In this last of a five part series, we end our review of interpreting twenty-one current economic indicators with the conclusions that may be drawn from their impartial analysis. Unlike news agencies and business channels that tend to sensationalize, spin or opine without supporting data, I have no vested interest in what those conclusions may be, other than appropriate for where these data lead.

We separated information into four parts:

• Part One http://www.socyberty.com/Economics/Current-Economic-Conditions-Explained-1-A-Five-Part-Series.376083 reviewed data relevant to Economic Cycle Momentum;

• Part Two http://www.bizcovering.com/Investing/Economic-Cycle-Explained-Part-II-Monetary-Indicators.385567 covered Monetary Indicators;

• Part Three http://www.bizcovering.com/Investing/Current-Economic-Conditions-Explained-3-Sentiment.423213 discussed the all important Sentiment indicator; and

• Part Four http://www.bizcovering.com/Investing/Current-Economic-Conditions-Explained-Part-Iv–Valuation.432971 analyzed Valuation models for the current market.

Economic Cycle Momentum

This is the point at which the US economy is in its economic cycle. Economic cycles occur about once every seven years, and are characterized by

1. Growth, Optimism and Low Interest Rates

Growth in employment, increases in the production of domestic goods and services and generally an upturn in the stock and housing markets, with increased positive sentiment

2. Slowing Growth, Higher Interest Rates and Rising Unemployment

As “full employment” is achieved, and growth in business production begins to exceed what businesses and people can consume, the Fed increases short term interest rates to “cool” growth to sustainable levels. Businesses cut back production. This usually includes layoffs, increasing unemployment and a plateau in the stock and housing markets, with accompanying more negative sentiment.

3. Economic Contraction, High Levels of Pessimism, Lower Interest Rates

As employment rates fall, carrying with them sales and tax revenues, domestic production reaches a “trough.” Sentiment is very negative. Businesses cut costs. At this point the economy has contracted to the degree necessary to absorb excesses produced in its growth period. Generally, the Fed will lower interest rates, making money cheaper, investment potential more lucrative, and growth begins to resume.

Nearly all of the eleven indicators we evaluated were lower in 2007, correctly predicting an economic slowdown in 2008. Recently, economists have opined that this recession did indeed begin in early 2008. In its thirteenth month, it is likely to be the lengthiest slowdown since 1932. With respect to the three cycles described above, this cycle is best described as in its “trough.”

Monetary Indicators

The Federal Reserve Bank is charged with the responsibility to maintain price stability and full employment. The means by which the Fed achieves its objective is primarily by manipulating short term interest rates. When banks and others have access to “cheap” money, the incentive to lend and invest increases. When the economy is growing at an unsustainable pace, the Fed raises interest rates to slow growth and contain potential inflation. When the economy is contracting, the Fed lowers interest rates to increase growth.

As you may have heard, the Fed has lowered short term rates virtually to zero. By any measurement, monetary policy is extremely accommodative. This indicator also points to a trough in the economic cycle, with the Fed taking unprecedented measures to promote economic growth.

Sentiment

Sentiment, a very predictive indicator, is a negative corollary to the health of the stock market. What this means in simple terms is that the higher the positive sentiment is, the worse time it is to buy, and vice versa. Sentiment is as low as I have seen it in my career, which began in 1971. This indicator is extraordinarily positive.

Valuation

Sometimes the previous indicators can point to a “buy” signal, but the market may still be trading at too high a price to be considered a bargain. Currently, the price/earnings ratio of the S&P 500 Index is trading at slightly under its historic average price, and is cheaper than it has been in decades. It is no wonder that value investor Warren Buffett has issued a rare public statement that he is aggressively buying stock, something he has not done since the mid 1970’s.

The “Fed model,” or comparison between the yield on the 10 year Treasury note and the earnings yield on the S&P 500, shows that the latter is 65% higher. Further, the dividend yield on the S&P 500 is higher than the yield on the 10 year Treasury note. No higher “buy” signal has been present in my lifetime.

Conclusion

I have seen circumstances like this at only one other time in my life, and at that time I was working my way through college with no money to invest.

Am I advising that you re-think your opinion to “never putting any money into that @#*% stock market again”?

Well, maybe. First you have to pass the following test.

1. You do not need the money you are investing in the stock market for AT LEAST five years.
2. You know that the market is very, very volatile, and can easily swing in both directions by 20% or more. If it swings down, you will buy more. In no circumstances will you sell in a downturn.

3. You know that the stock market is a “discounting mechanism” that predicts the health of the economy in six to nine months. Standard & Poor’s estimates that 2009 quarterly earnings will be:

• First Quarter – $13.83

• Second Quarter – $13.51

• Third Quarter – $15.02

• Fourth Quarter – $15.61

With the estimate of lowest earnings in the second quarter, you know that we are now six months prior to this estimated turnaround.

4. You have an investment strategy (e.g., value, growth, etc.,) or will seek professional counseling, if needed.

If you answered “yes” to all of the above questions, then investing in the stock market now may be the single best financial strategic decision you have made in your lifetime.

As a final note, “Barron’s Magazine” published an article last December 29 titled “A Bull Market in Lies,” which asks “Why does it seem as if everyone except you was smart enough to bail out before the market’s plunge began?” The fact is, very few investors did that. If you are one of many (including Warren Buffett – CEO of Berkshire Hathaway, Larry Ellison – CEO of Oracle, Steve Ballmer – CEO of Microsoft and Steve Jobs – CEO of Apple) who did not, consider this. Anyone who did sell everything before the downturn must be right twice – when getting out AND when getting back in again.

If you didn’t sell, you’re in good company, and unless you think that the US has permanently lost its place as the most significant financial powerhouse in the world, your decision to hold will be one for which you will likely be very grateful in the next few years.

If you have any extra money, this would be a great time to add to your investments. If not, just remember that your strategy to hold through this downturn was the same as Warren Buffett’s (and he’s been pretty good at this for the last few years).