Economic models and analysis that rely on the consistent application of fewer indicators often yield better and clearer forecasts.
Unfortunately, most of today’s market “experts” have apparently never heard of that concept.
Former Federal Reserve Chairman Alan Greenspan was famously fond of obscure economic statistics and data points. Economists in general love to underscore arguments with pet indicators or proprietary indexes.
And the financial media, of course, love to hype any of the hundreds of economic data reports that are released every week. Whatever they think they can spin for ratings.
All of these indicators never point in the same direction at the same time, so if you try to follow them all, it can lead to confusion, frustration and some really bad investment decisions.
Let me show you a smarter way to cut through the static and get to the truth about the economy and what lies ahead for the market.
A Day Late and A Dollar Short
The best way to avoid falling into these traps is to identify and follow a set of indicators or data points that have a reasonable track record of success.
A major mistake that many investors make when evaluating economic indicators is to focus too much attention on lagging indicators. Lagging indicators often deteriorate after the economy is already in a recession and improve after conditions have troughed; stocks often post their biggest gains in the first six to 12 months after the economy exits recession.
My favorite quick and simple indicator of the US economy’s health is the year-over-year change in the Conference Board’s Index of Leading Economic Indicators (LEI). When this year-over-year change is negative, it’s a good sign the US is headed for recession; when the year-over-year change in LEI turns up, it’s a signal that recovery is on the way.
This graph tracks the year-over-year change in LEI going back to 1960. The official start and end dates for every U.S. recession since 1960 are shaded.
The Business Cycle Dating Committee (BDC) of the National Bureau of Economic Research (NBER) is the accepted official arbiter of the beginning and end of US business cycles.
But the business cycle dates provided by NBER aren’t particularly useful for investors, save for historical purposes.
It wasn’t until December 2008 that the NBER established that the most recent recession started in December 2007. Then, in late September 2010, the NBER finally declared that this recession had ended in June 2009.
Not exactly the type of advance notice that you need to profit and protect yourself.
But those of us who follow LEI do typically get an advance warning. As you can see in “Leading Indicator,” the year-over-year change in LEI has turned negative before every recession since 1960.
In the most recent cycle, LEI flashed recession in October 2007, two months before the downturn started. At that time, many economists and market pundits—armed with more complex models–forecasted only a short-term slowdown or a shallow recession.
In July 2009, when many pundits called for continued weakness and the potential for a second financial crisis, LEI turned positive, indicating the recession had ended. Investors who followed these signals would have avoided being overly invested in 2008 and early 2009, one of the worst periods for U.S. stocks in market history.
And those who saw the signal to buy in summer 2009–as I did–participated in one of the most dramatic rallies in the past century. Personal Finance readers were snapping up select technology, energy and industrial stocks well before most investors realized the market had turned.
And we have the profits to show for it.
In fact, we’ve beaten the market over the last three-, five- and 10-year periods. In times like this, you need that kind of proven, battled-tested strategy on your side.
Learn more about the leading economic indicators we use to stay one step ahead of the market with a risk-free trial to Personal Finance. You’ll get immediate access to my current investing strategy for this volatile market, my complete list of recommendations, plus free copies of my three newest Special Reports–just click here.
City by the Bay
Elliott Gue is thrilled to be returning to San Francisco this year and invites you to join him at The MoneyShow, August 10-12, 2011, at the San Francisco Marriott Marquis Hotel. Be there as recommendations and advice are revealed for how to best position your portfolio for profit–in 2011 and beyond. As this new era of investing unfolds, smart investors know it’s imperative to stay informed and educated. The MoneyShow is your one-stop resource for the most comprehensive education, efficient research, and valuable advice. Don’t miss out…register FREE today and be sure to mention Priority code 022447!