Importance of Economic Indicators

It’s the third or fourth day of unfreezing in the credit markets, as reflected by lower interbank lending rates (i.e. LIBOR rates) and declining short term corporate borrowing rates (i.e. commercial paper yields). But those rates are still high and the thaw is coming at a painfully slow rate. Good companies are still having a tough time paying bills while running their businesses. Regardless, the global flood of government-backed money into banks has at least changed the direction of the credit crisis. Let’s hope it stays that way. We’ll keep an eye on this. Our other eye can now refocus on the big picture: the economy as a whole.

From Worse to Bad
Thanks to government intervention, the chances of avoiding Great Depression 2 have improved. Eventually, we may have to worry about inflation, tax, and federal budget implications of all this money flying around. For now, the most important thing is to keep roofs over as many peoples heads as possible and soup kitchen lines as short as possible.

So why the f*** did the Dow plummet 733 points or 8%?!?! Like I said in my Oct. 11 post, even if credit unfreezes, we still need to think about the underlying economy. And today we got the numbers on two key economic indicators: retail sales and the producer price index.

Retail Sales Figure
I've suggested that moving forward, “we won’t be buying as much as we used to.” I’m not qualified to quantify a decline, but my tone was pretty negative. Perhaps I was too bleak, but it turns out the opposite certainly wasn’t true. Today, the Commerce Department told us that September retail sales fell 1.2% month-over-month. That may sound like a small number, but let’s not forget how big the economy is. Let’s put it this way: if normal body temperature of 98.6 degrees rose by 1.2%, you have a slight fever of 99.8 degrees.

Nobody Likes Surprises
So, a 1.2% decline. What idiot wasn’t expecting a decline in retail sales? Well, an important survey of pretty smart economists revealed an expectation for 0.6% decline. That means the actual number was 0.6% (or 60 basis points) worse than the expected number. This is a big margin. What if Obama is ahead in the polls, but come November he loses the election. That would be unexpected, right? Well, when it comes to worse-than-expected economic data…

…the Stock Market Sells Off
Remember, stocks reflect expectations. Most would argue that weaker-than-expected retail sales caused much of today’s 733 point decline. Another chunk of that decline probably reflects a new expectation for worse-than-initially-expected economic data to come. In other words, expectations for the economy are deteriorating. And for those who believe we're in recession, weaker data means a deeper or prolonged recession.

If you can follow this logic, then you’re probably qualified to discuss the day-to-day swings in the stock markets at your next cocktail party.

More Cocktail Party-Talk
The Dow closed at 8,577 today. That’s 1.5% higher than Friday’s closing price of 8,451. Hmm. I might argue that people think America’s economic prospects look better today than they did Friday. But not as good as it did Monday when it closed at 9,387.

Whatever the case, these swings reflect uncertainty. And uncertainty translates to volatility. And there's still a lot of very uncertain data to come.

Look on the Bright Side
The Producer Price Index (an important measure of inflation) fell 0.4%, as expected. Why did they fall? Oil prices are down. At $73 per barrel today, oil is down 50% from its July 11 high of $147. That means all of the oil derivatives just got cheaper. These include gasoline, jet fuel (plane tickets), heating oil, plastic, and all kinds of chemicals. Things are getting cheaper. Enjoy.

One More Thing
Today’s retail sales metric reflects September performance. The Dow opened Oct. 1 at 10,847 and closed Oct. 15 at 8,577, down 21% in 15 days. If you have stocks in you 401k plan, that sucks. October has been a crappy month. At the end of the month, how much do you think retail sales will have fallen?

Beware of the Stock Markets

The Dow Jones Industrial Average had its best day ever, jumping 936 points or 11%. This doesn’t make you an idiot for not throwing all your money into the stock market on Friday. Such a move would’ve been an attempt at market timing and it is a dangerous game. Market timing is the stock market equivalent of playing roulette and putting all your chips on one number. Okay, so it’s a little different.

Why Do the Stock Markets Fluctuate?
Stocks reflect expectations. Finance theory says a stock reflects today’s value of all the money that a company will make (after paying its bills) in the future. On a given day, if the future looks brighter than we thought yesterday, the stock will go up. In the last few weeks, due to freezing credit markets and evidence of a deteriorating economy, the outlooks of almost all companies fell. And so did their stocks. But stocks often get oversold, presenting strong buying opportunities.

Why Do Stocks Get Oversold?
The most common explanation is panic selling. Let’s take you for example. You see your 401k plan fall 25% and you’re feelings get hurt. You don’t want it to fall further, so you instruct your 401k administrator (e.g. Fidelity, Blackrock) to take your money out of stocks and put them somewhere else (e.g. cash, money markets, bonds). You’re not alone; millions of people do this. Even rich people were doing this; hedge funds have been reporting all kinds of problems because their investors wanted their money back. All this asset reallocating involves forced selling, and then stocks fall even further causing more panic.

A lot of people argue that stocks initially fell on weakening expectations, but they fell way further on panic and emotions. This is when level-headed investors like Warren Buffett start investing. In fact, Buffett very recently poured billions of dollars into Goldman Sachs (GS) and General Electric (GE).

Why Were Stocks Up So Much Today?
Simply put, today’s outlook was better than Friday’s outlook. In their continuing efforts to unfreeze the credit markets, global governments over the weekend opened the floodgates of cash injections, backstops, bailouts, and insurance. I’m sorry, but even I can’t keep up with what’s being offered. Credit may be unfreezing as banks seem to be lending to each other a little more (as reflected by lower LIBOR rates). One bank (Mitsubishi) invested a ton of money in another bank (Morgan Stanley); that suggests some banks aren’t afraid of catching STDs anymore (see my previous posting).

What Don’t We Know and What Do We Expect to Know?
Well first of all, the banks and the credit markets were closed today in the U.S. (Columbus Day) and Japan (Health and Fitness Day). As such, we don’t know for sure how they’ll react to this weekend’s news. And remember that $700 billion bailout plan that everyone was talking about? That still hasn’t been put into play.

Again, stocks reflect expectations. Stock investors expect U.S. and Japan banks to respond positively to this weekend’s news. Stock investors also expect the $700 billion bailout plan to work to at least some degree.

How To Play This Market
If you’re convinced we’re near a bottom, then it’s still not too late to start moving money into the markets. To put things into perspective, the Dow is down 34% from a year ago. On Friday it was down 41%. However, you should invest a little bit at a time over a period of time (i.e. dollar cost averaging). And make sure you’re investing money that you won’t need within the next two to ten years. Most experts and investors aren’t convinced the stock market will just shoot up; if this were the case—trust me—the Dow would’ve closed much, much higher today. Uncertainty put a ceiling on the stock markets today. And uncertainty translates to volatility.

Before You Go…
There’s still a lot of news to come out. Some of it could be bad sending stocks down. At this point, expectations are so low that even no news would be good news. We’ll see.