The Investment U E-Letter
Friday, August 8, 2003 * * * * * * * The Infallible Indicator, and What It Means for Your Investments
By Dr. Steve Sjuggerud
President, Investment U
It's remarkable… an indicator you can't ignore.
It has made only six predictions since 1970. And all six predictions were exactly right. The predictions were for recession. There were six predictions, and there have been six recessions since 1970. That's a perfect record for 33 years. This indicator has a perfect record of predicting bad times. And it can be used to forecast good times as well. Best of all, it's simple to track, and I highly recommend adding it to your arsenal of investment tools. Knowing how to use this indicator to forecast a coming recession-or the lack of one-can keep you from rearranging your portfolio in anticipation of a market shift that never comes. Its Last Two Predictions… The last time this indicator said a recession was just around the corner was from July 2000 to January 2001. According to the National Bureau of Economic Research (www.nber.org), the officials who date recessions, the last recession lasted from March 2001 to November 2001. So the prediction was perfect - signaling well in advance the oncoming economic malaise. The previous prediction was from June 1989 to December 1989. The recession lasted from July 1990 to March 1991, according to the NBER. The indicator was a little early that time, but it was accurate. The other four recessions came in 1970, 1974, 1980 and 1982. All of these recessions were preceded a few months in advance by a prediction from this indicator. What The Indicator Is… It's really simple. It's when short-term interest rates rise above long-term interest rates. This is a rare occurrence. The last three times it's happened have been late 2000, late 1989 and mid-1981. There is a good reason it's a rare occurrence: In a world with little inflation, long-term interest rates should be higher than short-term interest rates. It comes down to risk… If I lend you a dollar that you're going to pay back tomorrow, I don't worry about my risk, and don't demand much in interest. But if you're going to pay me back in 30 years, then my risk is higher, and it makes sense for me to ask for more in interest. Why do short-term rates ever rise above long-term rates? It's generally because Alan Greenspan (at the Federal Reserve) is trying to slow down the economy. His main tool to slow down the economy is short-term interest rates. If he raises them significantly - to levels above long-term interest rates - then he's bringing out all the stops. And it results in recession a few quarters down the road. Judging by history since 1970, it happens every time. What The Indicator Is Saying Now Actually, right now Alan Greenspan is not trying to slow the economy down. Far from it. He's trying to juice it with all he's got. Short-term interest rates are at multi-decade lows, and the spread between short-term interest rates and long-term interest rates is at its highest percentage in history. This should (in theory) have an incredibly stimulating effect on the economy. Much of the stock market rally in the last year can be attributed to the ultra-low interest-rate environment in place right now. Bottom Line It doesn't happen often, but when short-term government interest rates rise above long-term interest rates, watch out. A recession is around the corner. However, today, we're in the exact opposite position. Judging by this (so far) infallible indicator, there's no recession on the horizon. Today's IU Cribsheet - You can track the Infallible Indicator at: www.bloomberg.com/markets. Right now, as that page shows, 10-year U.S. Treasury bonds are paying over 4%, while the Fed Funds rate is 1%.
- Another good web site is www.bankrate.com, which provides news and other information pertaining to interest rates (and other personal-finance issues).
Good Investing,
Steve | 
