I’m happy to share another guest post from Troy at markethistory.org. Hopefully it provides you with some practical insight into the stock market and investing. And if you’d like to contribute a post yourself, go to my contact page and send me a couple ideas you have in mind. Enjoy!
Most of the short term fluctuations in the market are random. However, the medium-long term outlook for the U.S. stock market is not hard to understand. It is driven by the state of the U.S. economy and corporate earnings. The good news is that the stock market lags the economy. So stocks will only fall significantly AFTER the economy has deteriorated significantly. Here are 3 economic and earnings related indicators that you should follow.
Employment report: Employment growth and wage growth
The U.S. Employment Report is released on the first Friday of every month. There are 2 key components to this report, and you should focus on them both.
- Employment growth. This is either a positive number (more jobs created in the past month) or a negative number (more jobs lost in the past month).
- Wage growth. This is a percent.
Employment growth that’s positive is good for the economy, which makes it good for the stock market. It means that more people have jobs and can increase their consumption. On the other hand, negative employment growth is bad for the economy because people are losing their jobs. Less jobs means less consumption, which puts downwards pressure on the U.S. economy.
So when you see that employment growth starts to slow down for 3 consecutive months, it’s a sign that the U.S. economy is about to enter into a recession. That’s also a sign that the U.S. stock market will enter into a bear market.
Wage growth is important because it signals inflation. Wage growth typically remains flat until the final stage of the economic expansion, when wage growth and inflation go up together. Hence, rising wage growth is a sign that the current economic expansion (and bull market in stocks) only has a few years left. So be careful.
Retail sales growth
The U.S. releases retail sales growth as a percentage once every month. This is important because consumption accounts for more than 70% of U.S. GDP! There is the headline retail sales, but you should not look at that. Retail sales has 2 components that you should eliminate: auto sales and gasoline sales.
Auto sales will fluctuate randomly depending on government programs (e.g. Cash for Clunkers in 2009). Hence, a “good” month for Retail Sales might only be good because auto sales temporarily spiked. Without auto sales, Retail Sales that month might have been weak.
Likewise, gasoline sales are heavily impacted by the price of gas. So if Retail Sales fall because gasoline prices fall, that doesn’t mean consumption is slowing down in the U.S.! It merely means that gas prices are cheaper.
Retail sales is a data whose value rises pretty consistently in an economic expansion. So when Retail Sales cease to grow and go flat for many months (i.e. 6 months – 1 year), it’s likely that the U.S. economy is about to enter into a recession. That recession will push down the U.S. stock market.
S&P 500 forward earnings
Yardeni releases S&P 500 forward earnings once every week. The forward earnings number is how much analysts predict how much all the companies in the S&P 500 will earn in the next 12 months (1 year). This is a very important indicator because like the economy, corporate earnings drive the U.S. stock market in the long run. Rising corporate earnings is bullish for stocks, while falling corporate earnings is bearish.
When the S&P 500 forward earnings number goes flat and ceases to rise for consecutive months (i.e. 3 months), it’s an almost guaranteed sign that a corporate earnings recession is coming. Hence investors should be wary of investing in stocks.
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