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New economic realities require new indicators

The ups and downs of the stock market and economic growth — or lack thereof — aren’t random. But they are difficult to understand at times. May-Investments developed its own Leading Economic Indicator (LEI) that helps the firm understand the current economic environment. Today’s LEI readings forecast continued economic growth during the months ahead.

May-Investments developed its

in-house indicator rather than rely on the more traditional LEI calculated monthly by the Conference Board. With the Federal Reserve adopting Enron-style, off-balance-sheet financing vehicles to move the government’s new bond issuance out the doors into buyers’ hands, the old economic indicators are at risk of becoming obsolete. Investors face difficulty understanding whether today’s economic growth is a mirage, an encouragement, or a house of cards about to fall and take them down with it.

The resulting economic uncertainty causes many investors to remain on the sidelines for fear of a repeat of the 2008 banking panic. Unfortunately, “the sidelines” as represented by bank and bond interest rates, pay investors little or nothing. So savers are being hurt by Federal Reserve low interest rate policies crafted to benefit bankers instead of savers. Long-term investors are being asked to use yesterday’s economic indicators in spite of the apples-to-oranges comparison between the economic environment that preceded the 2008 collapse of Shearson Lehman and the capital-starved world we live in today.

Investors could ignore the big picture, but 2008 proved that approach is too risky. Investors could remain on the sidelines, but inflation destroys the value of money held in the bank while food, energy and import prices soar higher. Some investors decide to use old indicators, ignoring the sea change in monetary policies that have been adopted since 2008. That approach has worked fairly well since the market bottomed in March of 2009. On the other hand, ignoring the new reality won’t make it go away and doesn’t mean it won’t eventually matter — a lot.

Built in house and updated monthly, the May-Investments LEI shows the economy began a sharp decline in mid-2008 a few months before Lehman’s bankruptcy and the Wall Street implosion. Through 2009, the economy remained mired and didn’t actually turn up until mid-2010 — despite traditional indicators that showed the economy recovering a year earlier. The old indicators put too much emphasis on low interest rates, a traditional indicator of stimulative Fed policy. In fact, low rates were put in place to bail out the distressed banking sector. But bank regulators were busy tightening bank capital requirements and lending rules that left banks shrinking loan portfolios and firing commercial loan customers — even those current on their loan payments. The world had changed, but the old indicators weren’t reflecting this new world.

As a result of developing our own indicators, we can say with more confidence the recovery that began in mid-2010 is still underway and isn’t a mirage. Retail sales and drilling activity turned up early and remain positive. Corporate profits have fully recovered. In contrast, small business confidence remains spotty. Even bank lending, which held back the recovery for months, recently turned up. These are healthy signs that give us confidence to invest for the long-term rather than hiding on the sidelines.

There are certainly concerns, and our indicators help us know where to look for them. Overseas activity has been weakening for several months as higher interest rates abroad slow down the rate of recovery in our export sector. More recently, the technology sector has dropped a bit, presumably (But who knows for certain?) as a result of problems facing the tech sector related to the tsunami crisis in Japan.

When we build client portfolios, we can design them to reduce exposure to some risks (we currently have little foreign stock exposure) while embracing other types of risk where evidence of the recovery gives us more confidence risk taking will be rewarded. Most importantly, our own indicators helped us keep our foot off the portfolio brakes when the market began rallying last fall. We still think brakes are important. Our best guess is that we remain in a “trading market” that could go down, a lot, just like it has soared off the 2009 lows.

At times we want to be playing offense, while at other times it makes sense to be more defensive. Our Leading Economic Indicator helps us make sense of this new monetary world in which we find ourselves. As I write this, that view is still encouraging.

 

About
Doug May, a Chartered Financial Analyst, serves as director of the mountain west region for Avant-Garde Advisors, an investment adviser registered with the U.S. Securities & Exchange Commission. Registration with the SEC does not imply a certain level of skill or training. Avant-Garde Advisors operates an office in Grand Junction at 744 Horizon Court, Suite 350. For more information, call 263-5126 or visit the Web site located at www.avantgardewm.com.
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