If someone asks you your opinion of current economic conditions, you're likely to answer in terms of yourself. That's understandable, but not necessarily accurate.
If you intend to use the answer to invest your money rationally, it's better to take a look at four broad economic categories:
- Where we are in the economic cycle (are we growing, peaking our growth, slowing down, hitting a trough in our slowdown)
- Monetary policy (is the cost of borrowing cheap, moderate or expensive?)
- Sentiment (is everybody more happy or depressed about the stock market?)
- Valuation (is the stock market expensive compared to its "normal" price?)
Industry as measured by output and the amount of available space utilized for that output has been growing steadily for the last five months. There's plenty of room to grow further. Orders and consumption are both growing at about 5%.
The unemployment rate, which peaked at 10.2% in October of 2009, has fallen to 8.9%. "Normalized" unemployment is approximately 4%, so there's plenty of room for improvement there as well.
The cost to produce goods is growing at 3%, but consumer costs are increasing at only 1%. This means that producers will soon have to raise prices, or cut their profit margins.
Last year the US grew by 2.7%, higher than the rate of growth in 2006 and 2007, before the real estate bubble burst.
All in all, it looks like we're in the beginning of our growth cycle and have plenty of room to grow further. When earnings are growing, it is an optimal time to invest, compared with when the economy is slowing and earnings are likely to decrease.
The Federal Reserve Bank is spending trillions of dollars buying Treasury Notes and Bonds (US national debt), in order to keep both supply and rates low. The six month Treasury bill pays .17%. That means that, for a six month investment, you give the Treasury $9,991.50, and in six months, they'll return $10,000.
This is called "accommodative" policy (the Fed will accommodate borrowers), and it's being done to keep rates low to increase borrowing by business to stimulate the economy.
Monetary policy is currently positive for investing, as growing businesses will return a much higher long term rate than tiny returns on bonds.
Warren Buffett says, "Be fearful when others are greedy; be greedy when others are fearful." There is no better explanation of sentiment.
When everybody wanted to buy "dot com" stocks, if you entered the fray, you probably lost money. When everybody wanted to buy real estate and "flip" it for a fast profit, if you entered the fray, you probably are continuing to lose money.
So, the higher that positive investment sentiment is, the more nervous you should be. I follow "Consensus Index," but there are others, including American Association of Individual Investors, Market Vane, First Coverage Market Sentiment, and they all point in the same direction.
Nearly 3/4 of people think that it's a good idea to get into the stock market.
That makes me very nervous. I like numbers like 28%, which was what positive sentiment was in 2008, when it most definitely was a good time to buy.
This is the measurement that tells you whether you're overpaying for the market as a whole. Right now, you're paying $13.56 for every dollar of earnings (sometimes called a P/E, or Price to Earnings multiple). The average market price is $15.82.
Not a bad price. If I hadn't been buying so much in 2008 and 2009, I'd be buying now, especially on days when the market dips significantly (like today).
Another way to look at valuation is to compare investing in the stock market with investing in a long term bond. I compare to the 10-year Treasury Note, because I don't think anyone belongs in the stock market that doesn't have a 10 year horizon.
Right now, the 10-year Treasury note will pay you 3.46%. Based on next year's projected S&P 500 earnings of $91.26, the earnings yield (earnings divided by price) is 7.16%. The potential return is more than twice that of long term bonds.
Another positive sign.
So, evaluating the risk level in these 21 economic indicators that lead me to these conclusions, I conclude that investing approximately 65% of long term (10 years +) investments in the stock market is the most rational asset allocation of risk versus reward in the current environment.
Women tend to live longer and earn less than men. These decisions are critical to our long term well-being. How do you make your asset allocation decisions? What is your opinion of current economic conditions?