Linking equities to the economy

Two more tenets cover the links between stocks and the US economy.
To equity investors, private sector growth matters more than headline GDP.
The composition of the S&P 500 is much different from that of the US economy.

In this second of a series describing my tenets for long-term investing, I’ll review the connections between the US economy and the stock market.


What will GDP do next?

Purchasing managers’ indices can be reliable indicators of future growth.
Manufacturing PMIs have led GDP growth rates by about three months.
Global PMIs have been telling us to expect accelerating growth ahead.

This is the first in a series describing my tenets for long-term investing — that is, the indicators I believe can stand the test of time. I like to think about the markets in terms of the business cycle, so let’s focus on how I make decisions about where we are in the cycle.

It’s particularly important to get the direction of the economy right. When I try to anticipate what GDP will do next, I find that the best indicator of an economy’s future growth is the purchasing managers’ index (PMI).


Tenets of investing for the long run

Chief Investment Strategist James Swanson highlights a few of the rules of thumb that he relies on to help him determine where we are in the business cycle and which markets are too rich, too cheap or fairly valued.

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Oil on the rise?

An oil supply shock could be a threat to the markets in mid-2014.
A rise in the global price of oil would cut spending and hurt profits.
If there is no quick solution, this could be a summer of market discontent.

The sudden and successful advance of Sunni militants from the Islamic State of Iraq and Syria (ISIS) into northern and western Iraq has captured our attention and raised some concern. There is no ignoring the risks to the markets from this rapidly developing situation. The most important bargaining chip — or weapon — in such a situation is a country’s biggest economic asset. For Iraq, that asset is its oil.

Flying back to Boston from Dubai last Friday, I was far from reassured as I thought over the six days I had just spent in the Persian Gulf region. While there, I asked everyone I could about the prospect for upheavals in the flow of oil and political power.


More saving and less inflation

Yields on high-quality bonds have stayed low despite the improving economy.
Such low yields — and high prices — seem to warn investors of potential dangers.
Still, tight spreads in the credit markets could be signaling better times ahead.

Typically, accelerating economic growth puts pressure on the bond market. As better performance is expected from investments in other types of securities, the anticipated return on bonds has to rise to offset higher returns on riskier assets. Furthermore, growth usually leads to inflationary pressures on consumer and producer prices because demand pushes up the costs of labor, products and services. Then central banks, nervous at the sight of wage and price inflation, force up interest rates.

But not this time.


Three things to think about this spring

Chief Investment Strategist Jim Swanson reviews why equity and fixed income prices have been going up, while China’s moderating pace of growth is a concern but not an immediate threat to the global economic expansion.

For more market commentary from MFS, visit
our YouTube channel.

If you have trouble viewing this video on YouTube, please
click here.


Business cycle matters

Perhaps the best approach to equity valuation is to gauge
the business cycle.
Misunderstanding the cycle can lead to big market moves and
investment mistakes.
Two measures may indicate if the current cycle is threatened
or moving ahead.

As we have discussed, it’s important to consider equity market valuation in the context of the business cycle. Since World War II, there have been 10 recessions in the United States, all preceded by expansions leading to excesses that made the pace of growth unsustainable.