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Economic Activity Drives Employment which Drives Stock Market

“Davidson” submits:

There are multiple factors which influence markets, but the strongest is economic activity which acts over the long term. By long term I mean the economic cycle which can be 5yrs to 11yrs. Investor activity over the short term (1-3yrs) is often driven by geopolitical events, changes in regulation and simply perception that something will do very well or very poorly (as in the Internet Bubble and worries of a poor economy the past 3yrs). But, in the long term it is economic activity which is reflected in employment levels which send investors into or out of equity markets. The chart below sums a few of the employment relationships.

The SP500 trend as shown by the SOLID BLACK LINE is preceded by the trend in the employment indicators. The SP500 peak in Oct 2007 was preceded by flattening trends in employment. The Temp Help and Job Opening indicators flattened ~12mos before Household Survey (Emp) which itself flattened ~12mos before the Oct 2007 peak.

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There is a logic behind these patterns. When more individuals are added to the employment rolls, they bring in new purchasing power as they make up for purchases postponed in the past. Rising employment drives economic activity higher! Once the needs of society have been met and the last few have been hired, extended credit and finished with their purchasing, society’s purchasing power ebbs. The economic history tells us that we have always gone to excess. Purchasing power ebbs when we have given credit to those who are last to be hired and least credit worthy. We do this because it has been a period of several years of strong economic activity and lenders extend credit thinking that economic conditions will continue to be strong. But, it is these last hired who are the weakest creditors who are the first to be laid off as the economy runs out of steam and they are the first to default. Then lenders tighten credit standards, economic activity contracts, employees are laid off and markets fall in correction. This has been the pattern for a long-long-long time.

Today, all employment trends are positive. This indicates greater future economic activity is ahead and as corporate profits increase we should experience higher stock prices.

With the lead time provided with employment indicators, I currently expect equity markets ($SPY) to trend higher the next 2yrs. With the typical cycles of housing and construction activity(shown in earlier notes) I expect employment contributions from these sectors to continue for 5yrs-6yrs. Investors who have remained in fixed income should begin to turn more bullish. We should see rising rates as they sell bonds to buy stocks. This is again the historical pattern.




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