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Why a Great Economy Means Bad Stock ReturnsBy
Tuesday, January 30, 2018
In tonight's State of the Union address, President Donald Trump will surely brag about today's low unemployment rate.
He has good reason to be excited about the economy...
Today's unemployment rate is 4.1% – the lowest we've seen since the dot-com era, when it bottomed at 3.8% in April 2000. And it's nearly the lowest we've seen since 1970.
But here's the important part for us as investors – the part that most people don't realize:
A great economy is typically bad for the stock market going forward...
To start with one example... Did you notice when I said the unemployment rate last bottomed at less than 4.1%?
It was April 2000 – one month after the dot-com bubble burst. The Nasdaq Composite Index went on to lose nearly 80% of its value.
"But that's a one-time occurrence, Steve," you might say. "You can't possibly tie a good economy to a bad stock market because of that one occurrence."
Good point. So let's take a look back at history...
Let's look back over the past 70 years to see how stocks performed each time the unemployment rate was less than 4.5% (remember, it's 4.1% today)...
The results are, frankly, amazing... If you bought stocks when the economy was in bad shape (when unemployment was 7% or higher), you would have made double-digit returns on average 12 months later.
On the flip side, if you'd bought stocks when the economy looked great (when unemployment was 4.5% or less), your stocks would have performed terribly, barely returning more than 1% after one year. Ouch!
When you tighten the data up to more recent times – since 1985 – the results become even more extreme. Take a look...
You would have lost 3.7% one year after the economy looked as great as it does today. And when the economy looked bad, you would have earned 13.2% in stocks over the following year.
I'm not suggesting that you use the unemployment rate as a stock market timing indicator... I just want you to be careful when you hear a politician crowing about the economy...
A good economy is not actually a great thing for investors, looking ahead.
As an investor, you want to load up on an investment when times look particularly bleak. And you want to get ready to sell when times look particularly rosy.
Why does this happen? Typically, when the economy starts overheating, the Federal Reserve steps in and raises interest rates to slow it down again. The Fed has already started down this road today.
My friend, we are having fun and making money here in the "Melt Up"... And I do expect these Melt Up gains to continue this year.
But looking ahead, be aware – the Fed is raising interest rates, and we are getting much closer to "rosy" than "bleak" times in the economy.
Trade accordingly...
Good investing,
Steve
Further Reading:
In the Weekend Edition of DailyWealth, learn more about President Trump's tax reforms – including why the changes could drive a wave of cash back to U.S. investors in the near term – right here: The Biggest Winners From Trump's New Tax Law.
Steve expects the "Melt Up" in stocks to continue – in the short term. But looking ahead, it's a different story... "My outlook for the long run (five to 10 years) is pretty darn glum," he says. Learn more here.
Market NotesCHECKING ON THE 'POOL INDICATOR' Today, one of our favorite gauges agrees that the U.S. economy is in full swing...
Longtime DailyWealth readers know that we keep an eye on the economy in non-traditional ways. In the past, we've looked at strong share-price movement in hotels, "fixer-upper" stocks, shipping companies, and ski resorts. That's because when American consumers are shelling out cash for non-essentials, it's a sign the economy is humming along...
Today, we're revisiting another sign of consumer confidence: the big uptrend in shares of Pool Corp (POOL). Swimming pools are the ultimate "want-not-need" item. And Pool Corp is the largest wholesale distributor of pool supplies and products. More important, business is booming... In its latest quarterly results, the company reported that its net sales grew 8% to a record $743 million, compared with $691 million the year before.
As you can see in the chart below, POOL shares have soared around 215% over the past five years. They're currently sitting at all-time highs. This powerful uptrend is more proof that things are looking "rosy" in the economy today. Keep an eye out for what's next...
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