The Economy

A vast number of issues affect the health of the economy:  How many people are working, how many would like to be but aren't?  How expensive is it to borrow money so businesses can buy new equipment or explore new technologies?  And are consumers confident in a bright tomorrow? As these things ebb and flow, they result in a pattern of expansion or contraction called the business cycle.

As the economy progresses through the business cycle, different sectors and industries move in and out of favor with investors.  More broadly, the market's performance is rooted in the business cycle - usually anticipating major changes in the economy by several months. When the economy does well more people are employed, consumer sentiment strengthens, people spend more money, sales increase, corporate profits grow, wages rise, tax revenue increases, individual debt is lowered, and corporations are able to either reduce debt, buy back shares, or borrow money for expansion. Near an economic trough, news will be very negative-making it easier to identify undervalued stocks for purchase.  At cycle peaks, on the other hand, it will be easier to eliminate and sell overvalued profitable stocks.

We focus on five key economic indicators:

• Interest Rates:   During a down-trending interest rate environment (slowing economy), equity markets tend to go up as investing in the alternative debt market is less attractive at low rates of interest and corporations can borrow money cheaply for expansion.  In an up trending interest rate environment (overheating economy), equity markets tend to go down

• Gross Domestic Product:  This is the total of all goods and services produced in the United States, expressed in dollars.  GDP growth indicates economic expansion, which typically leads to rising equity markets.  GDP decline reflects potential contraction or recession in an economy-shrinking earnings and bringing equity markets down

• Inflation:  Growth in inflation typically causes interest rates to rise.  Lack of inflation typically allows a more accommodative monetary policy, which spurs economic growth.

• Consumer Sentiment:  Two-thirds of economic growth is from consumer spending.  When people are happy and comfortable, they spend.  When they are more fearful and unsure about the future, they tighten their belts.  Less spending means fewer goods and services produced and sold, meaning lower sales and thereby decreased earnings.

• Leading Economic Indicators (LEI):  There are currently 10 indicators – such as initial jobless claims, building permits, money supply -- used to help predict future economic growth.  The LEI has been a fairly accurate forecaster of changes in the business cycle.

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