Economic Indicators

Every one tries to predict the future. Will the market go up, will it go down, will it go sideways, or should we just buy ammo and canned goods and pray?  The market goes nuts, loses 1,000 points in a day, oil companies are getting creamed due to the BP spill, and volatility is creeping back to the levels of 2008.  Why would anyone be optimistic?

I cannot claim to predict the future – nor would I want to (another post, a little more philosophical).  But I keep my eyes open.  The economic picture in our country is one big food chain.  Remember in grade school they taught you that the largest animals ultimately depended on the smallest; i.e., lions depended on gazelles, who depended on vegetation, who depended on water & sun, etc… It is the same with the economy.  Wall street banks depend on companies to make deals, those companies need cash to do that so they need to have sales, sales are only generated by people purchasing items, people only purchase when they have cash, and they only have cash when they have jobs. 

I guess to shorten that, so goes jobs, so goes the economy.  It can also work backwards, where if you see hard times ahead you start to layoff people trying to save your business. But the theory is they walk hand in hand.

As I walk around, I have noticed signs everywhere looking for help.  Restaurants, hotels, gas stations, home depot.  Accounting jobs are pretty stable in any economy (you need to count to see how much you made OR how much you lost), but blue-collar jobs tend to fluctuate to a greater degree.  I was just in Seattle and there were at least 5 help wanted signs within 5 blocks of my hotel. 

I just took a call yesterday from a sales rep I know at a payroll services company.  I asked how his biz was doing, and was surprised when he said they were having a great year.  They were up over 20% over 2009, they were not only seeing increased hiring at the firms they were with (their business model is based on headcount), but also an increase in new customers.

Again, the market may tank even more as we deal with the oil debacle and border control and whatever else pops up, but the base of our infrastructure, the jobs outlook, seems to be turning around.  With that I will have money in the market, just because I believe we are looking up, not heading back down.

More on Market Volatility

Amazing chart from Bespoke Investment Group:

50-day-average-absolute-daily-change-in-S&P-500

The pendulum swings both ways

When things are going great, the media talk up the economy and the upswing in the market goes past the underlying reality and far into the clouds. This is not a new thought, market reporters have talked about bubbles for years. Tulip mania, the tech bubble, oil (?).

Chart of the Tulip Bubble

It doesn’t take much to draw the conclusion that psychology has a lot to do with the creation and meteoric rise of bubbles. As prices start to increase, the “crowd” starts to follow the early investors into an asset – increasing demand at a time no one is really wanting to sell.

This increased demand creates a sort of euphoria where logic (or should I say “logik”!) goes out the window – and greed sets in. Valuations are forgotten, and rumors move the markets more than facts.

The fact that many people forget is that the pendulum swings both ways!

An asset “bubble” will pop once everyone has become euphoric and there is no one left to increase the demand. It is hard for a fire to get hotter once all the wood has been thrown on it! When demand finally plateaus, the only direction left is down. You can witness this in stocks, the high-fliers that can “do no wrong” eventually have a “good” quarter and the stock tanks. Notice I said “good” quarter – it doesn’t take a bad quarter to give investors a little worry… Just a less than stellar quarter will send some investors to the trading floor.

As the investors start to sell, there is no one left to buy (since everyone has already climbed aboard), and the price then starts to drop (law of supply and demand). Soon the asset starts to free-fall. Investors cannot sell fast enough, and demand is nowhere to be seen.

The moral of the story is that just as the asset price bubbled too high, it will also fall too low - as investors that would normal buy at a sane price would now find that price too risky due to the market sentiment. The worst scenario is that where a person purchases an asset at the very top of the bubble (trying “not to miss out”) and then sells at the bottom of the free-fall out of desperation. In times like these, the best thing you can do is invest in assets / stocks that you think can weather the turbulence, and sit back. The day-to-day emotional swings will only cause you heartburn…