MBA FaceOff Blog

The Best Economic Prediction Tool

Christopher Myers

“The stock market has predicted 7 of the last 5 recessions” is a common quip by economists who can’t seem to predict anything with reasonable accuracy (which is almost all of them).  Those who do their research would see that those extra 2 occurrences were mainly driven by the expectation of a post-World War II recession and the fear of a 1962 downturn that never materialized.  In both instances, the experts and the media were wrong.  The truth is that the stock market predicts 100% of everything.  Therefore, the job of the investor is to listen to the language of the stock market, which is different than that of “rational” human beings.

The language of the market is that of supply and demand.  The market looks out 6-8 months in advance and prices in future expectations to today’s values.  Therefore, the stock market will always hit rock bottom or mountain top many months before the economy changes course (think about how late the NBER is in declaring the beginning and end of economic cycles).  The tough part is not mixing up our own language with the market’s language when trying to understand the dynamics of what is to come.  Because of this, looking backward to understand the market and the economy is a science while looking forward is an art.

So what does the market appear to be telling us today?  First and foremost, the retail sector is about to have a huge holiday season.  The strongest stocks are dominantly coming from the retail and medical sectors.  GDP into the first and second quarter of 2012 is likely to be very strong, which will cause the Fed to make some tough choices about whether to reverse course on its decision to “hold rates steady through mid-2013.”  Most retailers won’t report their actual earnings until February or March next year, which is great reason to watch for the best of these stocks to advance rapidly into the coming bull market top. 

Along those same lines, the price of oil is getting ready to spike again.  With higher oil and commodity prices hitting the US consumer, which accounts for about 75% of U.S. GDP, we’re setting up to repeat how the consumer slowdown started in 2008.  Not to mention that the average U.S. consumer is already levered through their teeth.  The result of Fed’s loose monetary policy is coming to fruition and inflation is getting ready to run rampant.  The discussion at the Fed will shift back to the Quantitative Easing exit strategy which will push us back over the cliff.  Watch over the coming months as economic data gets better through the middle of next year but the market hits top 3-4 months beforehand (perhaps March 2012?).  Any sell off after the top will be discounted as “profit taking” and as a “natural correction” after the current cycle up is completed, but the damage will have been done.

Is all of this the equivalent of hocus pocus or reading tea leaves?  You are free to interpret the market as you please.  But be sure to ask yourself if you are imposing your language on the market or if you are truly listening to what the market is telling you.  The next time you listen to an economist, ask yourself whether they are imposing their own thoughts on the market or whether their economic predictions are grounded in what the market is actually saying.  The best predictor of the economy is the stock market itself.  Learn to listen to its message.

» View Team Profile