Investment U

The Investment U E-Letter: #351
Thursday, July 8, 2004

Is a Great Economy Great for Stocks?
By Dr. Steve Sjuggerud
President, Investment U

“Analysts: Economy Headed for Fast Growth”

It was a news story on Yahoo!’s home page yesterday, for all the world to see.

For investors, the instant reflex is to think that if the economy is good, then that’s good for stocks. After all, if the economy is growing, then businesses are growing, and making more money and their earnings should be higher and therefore their stock prices should be higher right?

Not so fast

Today, I’ll show you how you actually MAKE a TON of money in stocks by following the economy but you’ll be very surprised at the way you make your money.

Let’s get right to it

The Strange Truth About Stocks and a Booming Economy

“Many analysts are forecasting that the overall economy, as measured by the gross domestic product, will grow by 4.6 percent or better this year, the fastest in two decades.”

That’s what the first sentence of the Yahoo! article says. But does that mean you’ll make a ton of money too?

I ran some numbers, as I love to do. I went back to 1948, to test how the stock market does when the economy is growing at 4.6% a year or better. It has been a good half-century the economy was growing at 4.6% year-on-year over 30% of the time.

Amazingly, in the time the economy was growing at 4.6% a year or better, you wouldn’t have made ANY money in stocks. Specifically, stocks rose by 0.7% in the quarter following high economic growth (2.8% annualized).

While 99% of stock market commentators, brokers and financial planners get excited about a strong economy, the brutal reality is, a great economy is bad for stocks.

Stocks Soar When the Economy Is In the Tank

On the flip side, when the economy is shrinking (growing at a rate of 0% or lower), you make a mint in stocks

Stocks have risen at a rate of 25.8% a year when the economy has grown at a rate of 0% or less. Of course, the economy was only shrinking for a total of six years of the roughly 56 years studied. But the results are interesting, nonetheless

So how could this seemingly backwards relationship exist?

Why This “Wrong” Is Right

There are two explanations

The first is that the stock market looks ahead. Chances are, it already fell in anticipation of bad times. By the time the bad times finally arrived they were already “priced into the market.”

Second, when the economy is shrinking, everyone is pessimistic, and expectations are low – about stocks in general and corporate earnings in particular. So in a way, the bar is set very low. Therefore it doesn’t take much for stocks to exceed expectations and rise.

Today, we’re in the opposite place. The economy is growing. And corporate expectations are optimistic. (According to Bloomberg, analysts expect earnings to grow by 21% over the next year.) It won’t take much for stocks to fail to meet expectations.

And there we have it When the economy is soaring, it’s not a good time to buy stocks. And when it’s in the tank, load up.

That’s just the opposite of how 99% of people think. Maybe it makes too much sense

Today’s IU Cribsheet

• Judging by historical measures, stocks shouldn’t perform well, on the main, until the economy cools off a little more. To read about a fascinating alternative investment that is poised to do well this year, check out IU E-Letter #337 – How to Make Some Coin with Undervalued Coins.

Good investing,

Steve

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