Thursday, July 29, 2004
Investors pushed the Dow up by more than 100 points on Tuesday, "fueled by the best consumer confidence numbers in two years," the Wall Street Journal reported.
So stocks must go up when consumer confidence is high... right? If the Wall Street Journal believes it, and investors believe it enough to drive the Dow up more than 100 points, then it must be true...
Those Wall Street-types make my job easy... When will they learn this simple idea?
The brutal truth: We now have a good economy and optimistic consumers... but contrary to mainstream belief, that's bad news for the stock market.
A booming economy brimming with optimism is actually bad for stocks!
Let me explain...
Yes, ZERO GDP Growth Is Good for Stocks
The same profitable logic I used in my July 12, 2004 letter about the economy applies to the current consumer confidence number today... So let's briefly review the idea...
That letter was titled, "Is a Great Economy Great for Stocks?" I wrote it after a news story reported that this year's economic growth (real GDP growth) could be the best in two decades.
The assumption investors made from this news is that stock prices should therefore rise this year. Not so fast...
The forecast of economic growth for 2004 cited in the article was 4.6%. So I ran the numbers... I scoured through 60 years of GDP data and found that you barely make any money in stocks when the economy is growing at 4.6% a year (which was more than 30% of the time).
I also found that when the economy is shrinking (growing at 0% a year or less), you make 25% a year in stocks. Go figure...
Why You Make the Most Money In Stocks When Times Look the Worst
I gave two explanations in that e-letter as to why you make the most money in stocks when times look terrible...
The first [explanation] is that the stock market looks ahead. Chances are, it already fell in anticipation of bad times. By the time the bad times finally arrived they were already "priced into the market."
Second, when the economy is shrinking, everyone is pessimistic, and expectations are low... So in a way, the bar is set very low. Therefore it doesn't take much for stocks to exceed expectations and rise.
Turning to this week's Consumer Confidence figure - remember, the best figure in two years, the one that supposedly caused the Dow to rise by more than 100 points - I again ran the numbers. The two-year high in Consumer Confidence (as measured by The Conference Board) was reported this week at 106.1.
I checked the performance of stocks going back to the 1960s (as far back as we've had Consumer Confidence figures) to see how you would have done in stocks after a Consumer Confidence reading of 106 or higher.
You may be amazed to learn that stock returns - for any month after Consumer Confidence hit 106 or higher - were just 0.1%. That's terrible. (You can see a chart illustrating this by clicking here... The upper line reflects the performance of the S&P; the lower reflects consumer confidence during the same time frame. Note that consumer confidence appears highest right before stocks go down.)
Consumer Confidence has been above 106 for nearly 10 years since the Conference Board started measuring consumer confidence in the 1960s. And the annualized return on stocks since the 1960s when Consumer Confidence is over 106 has been 1.5%.
Bottom line stock buying tips
Based on history, and contrary to popular belief, you don't make money in stocks when Consumer Confidence is high.
On the contrary, when Consumer Confidence is low, say below 75, you make a mint in stocks... Stocks have risen at an annualized rate of 24.2% a year since the 1960s when Consumer Confidence is low (below 75). When you compare that to 1.5% a year when Consumer Confidence is high, it's easy to see when you ought to be a big buyer of stocks.
My advice for buying stock? Please, make sure you don't make the same mistake that most investors and Wall Streeters make... Understand that a strong economy and consumer optimism is not a recipe for stock market profits.
The reality (strange as it may seem at first) is exactly the opposite: The best time to buy stocks is when the economy looks bad, and consumers are dejected.
The math is simple. And it even makes sense, when you think about it. But Wall Street folks hardly bother looking at data going back to the 1960s, or the 1940s.
Remember what drives them: selling you stocks... and they're only looking at the present, not the past. History often reveals the best stock buying tips.
Today's IU Cribsheet
- If you have an interest in historic data, the best website for very long-term data on stock and bond markets is www.globalfindata.com. Check it out... and don't miss the free "Sample Data." Want a chart of gold going back to the year 1257? It's there. I use this site. If you're looking for long-term historical data, you should try it too...