Monday, February 8, 2010

The Economics of What Happened Last Year in Plain English

Most economic news is reported by someone with a vested interest in what you think.  I don't care what you think, but I do care that you get all the information you need to draw your own conclusions.
I.  2009 US Economy
Industrial output fell by 10%, after having fallen 3% in 2008.  Less demand for goods.  No surprise here.
Unemployment grew  from 7.2% in 2008 to 10% in 2009.  To get some historical perspective, in the last comparable recession, July, 1981 - November, 1982 (16 months), the average unemployment rate was 9.09%.  When President Reagan took office in January, 1981, the unemployment rate was 7.5%.  When the recession began in July of that year, it had fallen to 7.2%.  At the end of the recession in November, 1982, it was at 10.8%, and stayed over 10% for the next seven months.
Consumer Confidence fell nearly 30%, after having fallen 45% in the prior year.  Again, no surprise. 
Inflation averaged under 1/4 of 1% last year.  With less demand, both the price of commodities (like oil, lumber, etc.) and consumer goods fall.  Current inflation is virtually non-existent.
Inventories fell by 6.75%.  This contributed to our Gross Domestic Product, and many think this growth is artificial.  I do not share this point of view because the opposite (growth in inventories) is subtracted from GDP.  When you think of inventory building as wholesalers buying goods that sit on shelves (which does not contribute to growth), then depleting those inventories by selling them makes more sense as contributing to growth.
Orders for "big ticket" items fell by 20% from the previous year, but increased from  $160.1 billion in January to $167.9 billion in December.
Leading economic indicators, which include measurements that generally predict either growth or contraction in the future, fell 8% from the previous year, but increased from 98.9 in January to 106.4 in December.
You can see, with the exception of employment, that these important economic indicators all fell from the previous year, but are improving.  These are the data that economists generally consider when they say things like, "We're stabilizing, but are far from healthy."  As you can see, history shows that unemployment lags most other economic measurements after a recession, likely due to the reticence of employers to hire until they're sure than the economy is really on solid footing.
II.  Monetary Policy
You know that the Federal Reserve Bank has cut interest rates nearly to zero - .25% to be exact - in order to lower the cost of borrowing money for businesses.  Any who save money know that a six month Treasury Bill returns about the same, .25%. 
Many investors gauge whether the stock market is expensive by comparing the return on the 10 year Treasury Note with the expected earnings for the Standard and Poor 500 Index.  Right now, the yield on the T-Note is 3.66% and expected earnings for the S&P 500 are 4.5% of its current price - about a 20% premium. 
30 year Treasury bonds are paying 4.42%, good news for anyone who is buying a home because this is the rate mortgages are based upon.  Now, all you have to do is find a bank that's not too scared to make a loan.
III.  Sentiment
Investor sentiment is my favorite indicator because it is simple and more reliable than any other I review.  As Warren Buffet often says, "Be greedy when others are fearful, and fearful when others are greedy."
That's exactly how this measurement works.  When it's high, everybody wants to buy stock.  Bad sign.
When it's low, everybody is scared to death to buy stock.  It's cheap.  Good sign.
In 2007, the reading averaged 63.  In 2008, it was 28.  As you know, if you bought stock in 2009, you show quite a profit.  In 2009, it averaged 41, with a current reading of 58. 
The market is not the bargain it was in 2008, as we'll see below.
IV.  Valuation
This is a measurement of how much stocks cost.  To get some historical perspective, since 1926, the stock market as measured by the S&P 500 had an average cost of  $15.82 for every dollar it earned. 
Right now, it's at $18.29, up from $17.97 last year. 
Not cheap, but not expensive.  It depends on whether you think businesses will earn more money next year.  Standard & Poor's projects earnings of $58.71 for the S&P 500 in 2010, up from $50.70 (a 16% increase). 
So there you are.  Based on that information, your opinion is as good as anyone's.

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