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When it Comes to Advice: Trust but Verify

Tuesday, 22 Mar 2011 01:49 PM

President Ronald Reagan was known for saying “trust but verify” when discussing U.S. relations with the Soviet Union. It’s a phrase that I regularly use when I discuss the daily financial “news” with my business associates.

That’s because I have found that much of the “news” that’s reported by persons in the general financial media, and articles that are written by numerous financial market pundits, often contains statements and claims that are inaccurate and/or misleading.

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For example, numerous journalists and financial market pundits wrote articles during the past few weeks that discussed the possible occurrence of the following:

• Crude oil prices rising to $400 per barrel;

• Retail gasoline prices rising to $15 per gallon;

• The price of a broad basket of U.S. household goods and services doubling within the next few years;

• The U.S. economy falling back into a recession within the next 12 months;

• U.S. stock prices falling sharply during the next few months.

Although the occurrence of all of those events is possible, most economic and geopolitical factors suggest that the probability of the occurrence of any of those events is very small.

For example, the worldwide supply of crude oil was higher than the worldwide demand for crude oil during each of the past two months, which suggests that crude oil prices rose during the past few weeks solely as a result of the political protests and rebellions that have occurred in Libya since the middle of February and that crude oil prices will fall back to around $85-$90 per barrel once the likely outcome of those protests become clearer.

Because there’s a very high correlation between the price of crude oil and the price of retail motor gasoline, I would expect the national average price of gasoline to decline to around $3.10 (from its current level of $3.55) in the event that the price of crude oil were to decline to $90 per barrel.

The fact that U.S. households tend to reduce their consumption of gasoline whenever gasoline prices rise above $3.50 also suggests that gasoline prices won’t rise much higher than their current levels for the foreseeable future. Hence, there’s very little probability that crude oil prices will rise to $400 per barrel and that gasoline prices in the United States will rise to $15 per gallon.

Secondly, there’s a very small probability that a broad basket of U.S. household goods and services will double within the next three years – that the United States will soon experience a period of hyperinflation.

Although the prices of some goods and services will likely rise during the next 12-18 months as a result of likely improvements in the U.S. economy, there isn’t any data that indicate that inflation rates in the United States will double within the next three years. (Note: Most economists define hyperinflation as a doubling in the price of a broad basket of household goods and services over a period of three years. Some economists define hyperinflation as monthly price increases of 50 percent for many months in a row).

Meanwhile, an overwhelming number of economic statistics indicates that there’s a small likelihood that the U.S. economy will fall back into a recession during the next 12 months.

Instead, the recent readings on numerous leading and coincident economic data indicate that economic conditions in the United States will continue to improve and that the economy will expand at a healthy pace throughout the remainder of this year.

Because stock prices tend to move in the same direction of any given country’s economy, those economic statistics also suggest that U.S. stock prices will trend higher during the months ahead.

In regard to Reagan’s phrase of “trust but verify,” I have found over the past 25 years that a better course of action for persons who invest in the financial markets is to never trust an investment adviser, financial market pundit, or journalist unless that person provides data and information that clearly supports his/her comments.

In every edition of The ETF Strategist, which is a newsletter-like, financial market advisory service, I generally provide numerous statistics on economic and financial market developments and/or comments from proven experts that support my investment recommendations.

Note from Moneynews:

If you’d like to learn more about Mr. Frazier's analysis of the financial markets and how to focus on economic statistics that tend to indicate the future direction of the economy and stocks, try a free sample of his investment-advisory service, The ETF Strategist. Click Here to Find Out More.

About the Author: David Frazier
David Frazier is a member of the Moneynews Financial Brain Trust. Click Here to read more of his articles. He also writes two very successful investment newsletters. Discover more by Clicking Here Now.

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