Stock Market: Important Indicator Just Flashed a Major Signal
May 2, 2019
Is Now a Good Time to Invest in the Stock Market?
Dr. Seuss once wrote, “You have to be odd to be number one.” The same thing, it seems, applies to the stock market.
Most investors like to buy popular, fast-growing stocks. Even better if the underlying companies have just reported good news. Great fundamentals, after all, should translate into great returns.
If only it were that easy. If you want to rise above the legions of average investors, you have to think differently. Top investors understand the counterintuitive logic that good news often makes for lousy investment conditions.
Take the economy, for instance. Right now, the unemployment rate stands at four percent. That’s close to the low levels seen during the Vietnam War. The U.S. economy hasn’t enjoyed an unemployment rate this low since the dotcom bubble of the late 1990s.
Good news, right? Not really. Most people don’t realize that a great economy typically means lousy stock market returns going forward.
For starters, did you notice when I said the last time the unemployment rate dropped this low?
It was April 2000, one month before the tech bubble burst. Over the following two years, the Dow Jones Industrial Average went on to lose nearly half of its value.
And the other occasion? The Dow performed even worse. After Vietnam, investors suffered through a lost decade with zero investment returns.
Savvy investors won’t be convinced by two data points. So let’s see how things play out over a longer time frame.
To illustrate my point, I reviewed stock market returns over the last 70 years to see how equities performed in difficult business climates. Note again, the unemployment rate sits at four percent today.
The numbers surprised even me:
|
Unemployment Rate |
One-Year Return |
|
Less Than 4.5% |
1.2% |
|
All Periods |
7.7% |
|
Greater Than 7% |
11.1% |
(Source: Yahoo! Finance, last accessed May 2, 2019.)
If you had invested in the stock market when the unemployment rate rose above seven percent (when business prospects looked terrible), you would have earned double-digit returns over the next 12 months.
And when the economy has fired on all cylinders? Your profits plunged. If you invested in the stock market when the unemployment rate sat below 4.5%, your average return dropped below 1.2%.
Why does this happen?
Well, a weak economy usually means pessimistic investors, which allows you to scoop up shares at bargain prices. And as the economy recovers, the acceleration in corporate earnings provides a catalyst for higher stock prices.
Alternatively, a strong economy usually means expensive equity prices. Any disappointments, therefore, will result in big losses. And because corporate profits are as good as they’ll likely get, companies can deliver little in the way of positive surprises.
So, is now a good time to invest in the stock market?
I don’t like to use the unemployment rate as a timing indicator. You’d be far better off, at least in my opinion, to simply buy and hold wonderful businesses rather than trying to predict each stock market gyration.
That said, a strong economy should raise alarm bells. Right now, I get e-mails every day from readers asking whether they should go all-in on stocks or borrow money to invest. The data says such maneuvers often backfire, at least at this point in the cycle.
It might sound strange. Why get nervous when the economy is rockin’ and a-rollin’? My position sits well out of step with the mainstream consensus right now.
But as Dr. Seuss said, you have to be odd to be number one.
