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Market Indicators Off of the Beaten Path

GuruFocus.com
·3 mins read

- By Stepan Lavrouk

Most value investors tend to agree that it's a futile job to try to predict the future. For this reason, you won't hear people like Berkshire Hathaway's (NYSE:BRK.A)(NYSE:BRK.B) Warren Buffett (Trades, Portfolio) or Charlie Munger (Trades, Portfolio) talking about GDP forecasts or earnings projections.


With that being said, there are economic indicators that can be very useful - not for predicting the future, but for understanding where markets and the business cycle stand at any given point in time. Here are three economic indicators that you might not have considered before

Demographics

One of the most basic factors that determine whether or not an economy is on the right track is the demographics of the relevant country. A number of studies have demonstrated that peaks in market cycles have coincided with the years during which a particular population cohort (aged 30-50) peaked in terms of earnings and size. For instance, the baby boomer generation peaked in 1999 - near the height of the dotcom bubble.

Now, while this may seem like a rather crude indicator to use, there is actually a very logical rationale behind it. Data collected by Fundstrat Global Advisors, an investment research firm, demonstrates that the 30-50 year old band of a population drives most of the spending and investment in an economy - they are at or close to peak earnings, they are having children, they are spending money on real estate and taking on more debt, which stimulates the credit cycle. For what it's worth, the millennial cohort is just starting to peak in terms of size and earning power.

Bonds lead stocks

There is an old adage that the bond market represents the "smart money" that is being traded. And indeed, there is some truth to this - bonds tend to lead equities, rather than the other way around. High yield bonds show the greatest correlation to the stock market. One of the most commonly used bond indicators is the "spread," or the difference, between what high yield bonds earn and what investment grade bonds earn.

Yields on bonds are inversely proportional to the price of those bonds - the less in demand a bond, the higher its yield. Therefore, the wider the spread, the bigger the uncertainty felt by bondholders about the creditworthiness of weaker businesses, which is a leading indicator for stock prices.

Investor sentiment

Ironically, one of the most popular contrarian indicators is investor confidence. When the consensus view is that the market is going down, many investors tend to sell their stocks. This creates a self sustaining cycle which induces more investors to sell. When sentiment is depressed, prices are also depressed, which is in fact the best time to buy. Swimming against the tide is often the best strategy to pursue.

Disclosure: The author owns no stocks mentioned.

Read more here:

  • Warren Buffett: The Rationale for Issuing Preferred Stock

  • Warren Buffett's Berkshire Hathaway Bets on Scripps

  • Warren Buffett: The Value of Historical Data



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This article first appeared on GuruFocus.