Where I Think The Economy is Headed

Probably one of the most common questions in everyone's minds right now is 'Where's the light at the end of this economic tunnel?' This is a questions that is as difficult to answer as it is relevant. There are so many variables that come into play when determining the health of any economy - things like manufacturing output, employment, savings rates, etc. etc. etc. all play their part. Investors, who's job is essentially to play soothsayer in order to determine where their investments are headed, generally look at a few key economic indicators to determine where the economy is going. I'll explain a few of these and tell you my thoughts of where we're going

What Indicators Matter

If you watch CNBC for a couple of hours (not like I do that at all...not at all) you'll probably hear about some sort of 'economic indicators'. Although it is important to understand what the indicators mean, it is just as important how they relate to the health of the economy. Some are leading indicators - those that generally predict the future health of the economy. Others are lagging - those that change direction after the overall economy does. When trying to predict the direction of the economy, it is important to make sure you're making the right assumptions when using indicators.

Leading Indicators - These indicators will generally start going positive (bullish) early on when the next recovery takes place.

1. Wholesale Inventory/Sales - This number describes the overall inventory wholesalers are keeping in their warehouses. Generally, sales start dropping first and inventories soon follow as wholesalers cut back assuming sales declines will continue. The most recent inventories number was the lowest in 17 years and sales were still declining steeply
   
2. Housing Prices - Especially in this recession, housing prices and their direction, will largely dictate many other aspects of the economy. Intangible indicators like consumer sentiment, and business confidence will likely stay low if the value of homes continue declining. So far, housing prices continue to decline, albeit not as fast as they were last year.
3. The Stock Market - You might not realize it, but when trying to figure out the health of the economy, the stock market is a great leading indicator. The reason for this is because the market pretty much gives a picture of where investors think the economy is headed. They try to take into account all these indicators and make a judgement, whether it's up or down. Right now, the markets are still near the lows for his recession. However, they've been near the lows for several months now without breaking lower, indicating that investors may think the economy is at a low itself, but isn't ready to recover yet.

Lagging Indicators - These indicators will turn positive once the economic recover is well underway.

1. Employment - Companies hire and fire as a reaction to where they feel their business is headed. Generally, they want to have a pretty clear picture of the economy before hiring or firing employees. Therefore, employment figures generally trail the economic recoveries as businesses will wait to see some signs of the recovery before hiring again. Personally, I think the rate of unemployment increases is reaching a peak because of the panic layoffs that occurred late last year and early this year. I see the unemployment rate (which stands approx. 7.5% now) staying around 8% for a while until a recovery begins.
2. ISM - The Institute of Supply Management generally measures the manufacturing activity of the country. Manufacturing demand determines activity, and consumer demand determined manufacturing demand. Therefore, the ISM numbers will not increase significantly until consumer demand does.
3. Baltic Dry Index - This is a little less known, but I think still important index. It measures the international shipping rates for various dry goods, ranging from coal, to corn, to cars. I think it's an important index because, although it's a lagging indicator, it's one of the closest to being a leading one due to its elasticity. To me, it's the first lagging indicator to turn positive during a recovery. Interestingly, the index has experienced a strong rebound in the last month or so of over 10%.

Where I Think We're Headed -


With those indicators said, my thoughts on where we are in the economic cycle generally says that we're on the trailing end of the downturn. Although many of the leading indicators are still decidedly negative, they have been so for quite a while, and I expect some of them, namely housing prices to stabilize in the coming months. Properly exectuted (key word: properly) government intervention (i.e. TARP) can help speed us to the end of the downturn. However, just because we are coming to the end of the downturn, I don't think we'll be heading for an upturn soon. I think we're going to stay at these lows for at least the first half of this year, perhaps even all of it before we really start seeing some of those leading indicators recover. With that said, I believe as an investor, there are some really good opportunities to take advantage of now, namely very high quality banks, before the leading indicators start trending upwards again. The light at the end of the tunnel is there, and we can see it, it's just going to take some time to get to.

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I’ve said above. This includes consulting with a financial advisor.