The latest economic news has been horrible over the past two weeks, yet stock prices have rallied sharply. For example, the Dow Jones Industrial Average has advanced 13.8 percent since Nov. 20, the S&P 500 Index has risen 15.7 percent and the small-cap Russell 2000 Index has appreciated 17.8 percent.
That’s a very encouraging development for equity investors, because stock prices have historically bottomed and then trended higher over the ensuing months whenever equities were able to hold up in the face of bad news.
Here’s a sample of the most recent U.S. economic news:
(1) Manufacturing activity, as measured by the Institute of Supply Management, fell during November to its lowest level since May 1982.
(2) Orders of durable goods (such as household appliances, consumer electronics devices, and business equipment) declined during October to their lowest level since April 2005.
(3) Auto sales fell during November for the thirteenth month in a row, with sales from the nation’s big-three automakers declining approximately 40 percent compared to the same period a year ago.
(4) The employment situation continued to deteriorate during November, with private non-farm employers reducing their payrolls by 250,000 workers — the largest monthly job cuts since November 2001.
(5) Inflation-adjusted consumer spending fell during October for the third month in a row, declining at the fastest year-over-year pace since January 1991.
The fact that stock prices rose significantly over the past two weeks even though recent economic news has been overwhelmingly negative suggests that astute investors are now focusing on some potentially positive future economic developments rather than on the currently bleak economic situation.
Unfortunately, most mutual fund managers tend to allocate the funds that they manage in a manner consistent with past economic developments rather than to allocate those funds in a way that would likely benefit from positive future economic developments.
For example, most mutual fund managers currently have the majority of their clients’ assets invested in so-called defensive stocks — stocks that tend to decline less than other stocks during periods of slowing economic growth and that tend to appreciate less than other stocks during periods when economic conditions are improving.
Because most mutual fund portfolio managers tend to invest primarily in defensive sectors of the market only after stock prices have fallen sharply (near stock market bottoms) and to invest primarily in growth sectors only after stocks have risen sharply (near stock market tops), most mutual fund investors tend to realize returns that are significantly lower than the returns that they could generate simply by investing in a broadly diversified equity portfolio.
In contrast, I’ve always advocated selling stocks short and/or allocating the majority of one’s financial assets to cash-like securities during periods when the equities market seems to be peaking and investing in growth sectors of the market during periods when stock prices seem to be bottoming.
As a result of that investment approach, subscribers to my investment newsletter, The ETF Strategist, have substantially outperformed the S&P 500 Index since we began publishing that monthly newsletter last September.
For example, investors who follow my Conservative Portfolio recommendations have outperformed the S&P 500 by 32 percentage points since the inception of The ETF Strategist on Sept. 18, 2007 (through Dec. 3 of this year), while investors that follow my Aggressive Portfolio recommendations have outperformed the S&P 500 by 40 percentage points.
Click here for a trial subscription to The ETF Strategist.
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