A non-correlation of market cycle and business cycle

A non-correlation of market and business

The Business (same as economic) Cycle is supposed to lag the Market Cycle¹ by about 6 months as the stock market is a leading indicator of the economy. As of February of 2013, this has not occurred, therefore the US economy is in a non-correlation to its stock market.

The market has recovered most of its losses from 2007-2008.

The economy is still in a recession considering the high unemployment and under-employment and the poor GDP growth. The global economies are more inter-connected than before, and our trade partners are also not doing well. Though there have been some recent signs of recovery in the U.S. economy, the job recovery may never reach to its previous peak.

Is this non-correlation important to us, the retail investors?

For an economist, the Business Cycle is important. For an investor, the Market Cycle is important. The economists forecast business growth, GDP growth, job growth, housing start…, and plan accordingly. The investors care about the potential appreciation of their portfolios.

It could be the beginning of this non-correlation for the coming decade. There is a good chance economists can no longer depend on the previous correlation to use the market to predict the economy. As long as the market is moving up, the investors are not concerned with the non-correlation. 

However, most likely the market will correlate again in the future with the economy as there has always been a correlation as far as I can remember.


When the following reasons of this non-correlation change, then the correlation will continue and we will be back to normal.

The reasons for this non-correlation

1.       Most big companies are now global companies.

Hiring at these multinational corporations (MNCs) depends on where offer the greatest benefits, including low workforce salary, educated workers, tax credits, less tax …. A good portion of MNCs' incomes are from foreign countries. Hence the U.S. market is getting less correlated with the U.S. economy which uses local employment as a measurement.

2.       Too many government interventions.

The government bailed out too many companies that should fail. No companies are too big to fail. It has not punished the executives/bankers to get us into this recession thru their greed. The market may falsely expect that future failing companies will be bailed out.

3.       There is still much easy money.

Since the American recession, banks use government money to invest in the market instead of loaning it to small businesses and house buyers to stimulate the economy. In addition, the demands from businesses and potential house buyers have been reduced. Corporations have the highest cash reserves for a long while.

When the government borrows a lot of money (to the ceiling literally), everything including the market looks good. However, somehow and sometime the taxpayers pay for those debts to China, Japan and whatever other treasury buyers. Today the U.S. has a benefit: It will repay the debtors with depreciated dollars.

A country loses its competitive edge if a good percentage of the GDP is used for servicing those debts.  If the USA were a company that cannot service its debts, it would be bankrupt.

Most believe this is the prime reason.
 

4.       Regulations appropriate for the health of the market is typically not boasting the economy. The expected ObamaCare is discouraging small businesses from hiring.

5.      Today's market may not be a good market indicator if this were considered to be a commodity unit (a combination of natural resources including gold) or Swiss Francs instead of the USD.

6.       There are too many factors that influence both the market and the economy in separate directions. Examples include the recent shale energy discovery and never-ending wars.

What should be done

1.       The government cannot pump that much cash into the economy.

Depreciating our currency is a short-term solution at best as it would improve our trades both ways.

A depreciated currency would encourage foreigners to buy the United States’ assets that would not be good for long term. To illustrate, if the GE building were sold to a foreigner, GE would pay rents to a foreigner for years to come. It is similar to selling our know-hows to a foreign country - the seller has immediate benefit at the expense of losing its competitive edge.

2.       The United States government must address and service the debt better now! The high debt will deteriorate the United States’ competitive edge to foreign countries. A high percentage of our GDP to service the debts will not help the economy.

3.       Its citizens and the government need to bite the bullet with more taxes, more incentives to create jobs, less entitlements, less welfare… Ending the current two wars and avoiding future wars is almost mandatory to improve the economy.

4.       The economy cannot be recovered without job recovery. The money spent in creating jobs will be better spent than on welfare and unemployment benefits.

Footnote.

¹Freedy, my fellow commentator, said,

Tony, the market can only act as a leading indicator or proxy of economic activity if there is consensus on the direction. Sometimes what is coming in six months is fairly predictable but at other times when pundits are at odds the future course is fuzzy. So market indices are really tracking where consensus "thinks" GDP is going'.

To be clear a market index is a summary of where consensus believes the economy is headed and this sentiment is a proxy for forward earnings. For the playing stocks and not the index, it is their cumulative sentiment which acts a guide.

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Afterthoughts.

·         We can still use the past to data to predict the future. However, it can be getting less and less useful.

* The economy conditions changes. We did not have most today's regulations in the depression. Examples abound.

* Employment is one of the major metrics in the Business Cycle. Our economy may recover without recovering employment (unemployment ).

Why? The world is more globally connected. The corporations make more money by shifting jobs to any other country.

* QE, printing money, foreign loans (to China...), reserve currency, debt ceiling all mean the same: Live in a higher living standard that we can afford.

When Uncle Sam uses all the tools to maintain our living standard and being the world policeman (a paper one when our economy is screwed up beyond repair), he is running out of tools. Each tool is a temporary fix but a long term trap.

* The shale energy could save the entire US economy and another war could do the opposite. You cannot find this info from any economical charts and data.




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(c) 2013 Tony Pow

Disclaimer. I'm no responsible for your actions in your investment. Treat this as educational information and past performance does not guarantee future performance.