Investment Consult: Heed the economy&s vital signs

August 20, 2001

Short-term stock market fluctuations mean little. Instead, keep your eye on these broader indicators.

 

Investment Consult

Heed the economy's vital signs

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Short-term stock market fluctuations mean little. Instead, keep your eye on these broader indicators.

Lewis J. Altfest, PhD, CFA, CFP

Some investors have viewed the recent dips in major market indexes as buying opportunities, only to be sorely disappointed when the stocks they thought they'd nabbed at bargain prices sank even further. For example, a client, despite my warnings, placed a large portion of his holdings in technology stocks during the second quarter of 2000. By the end of the year, we were discussing the sale of many of these stocks, so he'd at least be able to write off a portion of the losses on his tax return.

Other folks simultaneously fear losing their money and missing the next market upturn. After a sharp decline in the morning, they call my firm, wanting to sell. By afternoon, after a rebound, they insist we buy. Another client, who was working at a business-oriented TV program, would call nearly every day, asking why we didn't appreciate and act on the anchorman's advice. It got to where I could tell how the market was doing just by the sound of this client's voice.

Then there are the people who are unfazed by short-term stock market gyrations. When I asked one physician whether she worried about the market's recent weakness, she smiled and said, "Lew, I know you'd call me if things really changed."

What, in fact, would signal a change that's significant enough to justify a fresh look at your investment choices? In my opinion, it would be a sizable shift in one or more of the following economic indicators, which are analyzed by Barron's, The Wall Street Journal, and the business sections of most big-city newspapers:

The inflation rate. A substantial, sustained increase in inflation could throw a monkey wrench into consumer purchasing power, corporate profits, and the Federal Reserve's ability to get us out of an economic slowdown. Suppose that in today's environment, the Consumer Price Index increased to 4 percent (on an annualized basis, excluding food and energy) and stayed at that level for three months or longer. That would point to trouble—even with the Dow Jones Industrial Average at 9,500 or higher. To lessen the impact on your portfolio, you would probably need to lighten up on stocks and move from long-term to short-term bonds.

Consumer confidence. The Consumer Confidence Survey, a monthly polling of 5,000 US households, attempts to measure changes in people's buying habits, by age and income. As of June 26, the Consumer Confidence Index stood at 117.9. (A score of 100 serves as a baseline.) A steady decline toward 100 would be worrisome, indicating that the public is less optimistic about the economy and might curtail spending. That could set off a chain reaction in the economy: Companies would experience shrinking revenues, which, in turn, would depress the value of their stock.

The stock market.As I indicated earlier, the market's short-term gyrations mean little. Even extended dips and climbs can offer misleading clues as to where the economy is headed. As noted economist Paul Samuelson has said, "The stock market has predicted nine of the last five recessions." However, I believe that a sharp decline in the Dow—to 8,000 or lower—would suggest a sluggish period that we're not likely to bounce back from soon.

The Federal Reserve System and the government. The actions of the Federal Reserve and the US government count because they play with real money. The Federal Reserve controls interest rates, and the government, through taxation and spending, controls the cash in our pockets. Pay more attention, though, to the Federal Reserve's actions than to Chairman Alan Greenspan's talk, which often contains rhetorical flourishes designed to influence public opinion. While long-term interest rates have declined, an increase could suggest that the economy is overheating, and cause renewed concerns about inflation. That, in turn, should signal you to shift more of your portfolio into fixed-income vehicles.

The trade deficit. The country's checkbook is overdrawn as we continue to import more than we export. A year-to-year increase of 10 percent or more in the deficit could spell trouble for the economy and weaken the dollar's value against foreign currencies. Any continued widening of the deficit would, again, indicate a move away from stocks.

How should you react if you notice one of these factors improving while another weakens? There's no simple answer; deciding what to do with your portfolio will not be easy. However, any sizable shift should be a signal to re-examine your asset allocation, as soon as possible.

The author, a fee-only financial planner, is president of L.J. Altfest & Co.( www.altfest.com ), a financial and investment advisory firm in New York City. This column appears every other issue. If you have a comment, or a topic you'd like to see covered here, please submit it to Investment Consult, Medical Economics magazine, 5 Paragon Drive, Montvale, NJ 07645-1742. You may also send a fax to 201-722-2688 or e-mail to meinvestment@medec.com.

 

Lewis Altfest. Investment Consult: Heed the economy’s vital signs. Medical Economics 2001;16:22.