Poor Economy=Poor Stock Returns?-Not Necessarily

The recent mortgage foreclosure moratorium probably results in even more delays in cleaning up the millions of home foreclosures nationwide and means the return of a healthy real estate market is still years away. Jobless claims remain elevated, and unemployment seems like it will be stuck at around 10% for some time to come. Signs of improvement, temporary census hiring, and the upcoming holiday season-none of it seems to making a dent in business hiring.

Some of you are wondering, “If the economy has all these problems why should I even stay invested in the stock market? A recent whitepaper by O”Shaughnessy Asset Management highlighted several misconceptions about the stock market that make the case for staying invested in a long-term investment allocation. Let”s look at these in order of their concern in a recent Gallup Poll:

Economic Growth versus Portfolio Growth
We would all like to see the economy growing faster, but economic growth does not always translate to stock market returns. In fact, since 1946, one to five- year forward stock returns have actually been higher when the economy is contracting. Low expectations and lower valuations usually occur during these periods-eventually translating into better returns.

Jobs and the Stock Market
Since 1929 the unemployment rate has shown to have a very low correlation with stocks returns. In fact, periods of high unemployment have actually resulted in better than average forward three and five-year stock returns. Unemployment could affect our personal risk tolerance, but it does not necessarily have a negative impact on future stock returns.

Taxes and Stock Returns
Some are concerned with the impact of potential tax increases on the stock market. Laying aside the economic impact, once again higher taxes were found to no correlation with stock returns.The average annual return of stocks during the 1950″s (when tax rates were highest) was 16.7%, while the average annual return of stocks during the 2000″s (when tax rates were lowest) was a negative 0.8%.

Consumer Confidence
Consumer confidence is a frequently cited economic indicator, but as a predictor of stock market returns, it is more of a contrarian indicator. Since the indicator began in 1952, the highest decile confidence readings have resulted in forward average 5-year returns of negative 2.42%, while the lowest decile confidence readings have resulted in average returns of 11.50%.

Valuations Matter
Economic growth, low unemployment, low taxes, and high consumer confidence are all things we would like to see for the U.S. economy. But none of these translate into strong stock market returns-what really matters is valuations. Both trailing and forward Price-Earnings ratios are well below their historical averages. So stay invested!

Have a great day!

Bob