Every couple months or so, we take the opportunity to answer some of the most frequently asked questions on the minds of our readers and listeners. Here are three taken from our weekend Big Picture podcast with Jim Puplava, which, in case you missed it, can be listened to by clicking here.
Question: How can you properly invest or understand what's going on with the economy or markets when so much of the government’s numbers are inaccurate, faulty, or manipulated?
Answer: We get this question or criticism a lot from readers and listeners since we often report on the most recent GDP number or cite the latest inflation figure released by the government. But really there are two common mistakes or misperceptions that need to be addressed with this question.
The first mistake that many people make is in terms of the data and the second mistake is in terms of the government figures. In terms of the first mistake, let’s assume for the sake of the argument that the government’s figures are inaccurate, faulty, or manipulated. In that case, yes, anyone using it would likely make incorrect or bad decisions—“garbage in, garbage out” as they say. However—and this is very important—the overwhelming majority of the data we use is not produced by the government but by independent research firms or organizations who are compensated, either monetarily or via their credibility, to produce the most accurate information possible. Some of this data is free and easily accessible on the web and some of it isn’t; however, the moral of the story is that if you mistrust the government’s numbers, then don’t rely on them—we don’t, but mostly because they are lagging indicators (looking in reverse) rather than leading indicators (looking ahead). One notable exception to this is weekly initial jobless claims, produced each week by the US Department of Labor, which often bottom and start to tick up before a recession.
The second most commonly believed mistake is that the US government’s numbers are wildly off base. Though many believe this is primarily due to overt manipulation, our research shows that the largest contributing factor in the inaccuracy of government data is a direct result of trying to measure the gargantuan size and complexity of the US economy—a herculean task fraught with possibilities for error. On top of that, we’ve seen the US economy undergo a massive change in the past 50 years, which has accelerated even more with the advent of the internet and the personal computer, away from manufacturing and more towards services. Since the economy is in a constant state of change and evolution, government agencies have tried to change their methods along the way, though it has always been and will continue to be a learning process. For more information on this, we did a special podcast looking at this issue more in-depth with Diane Coyle based on her insightful book, “GDP: A Brief but Affectionate History,” that we highly recommend listening to (audio link).
Q: When should I be concerned about a financial crash and what sort of things should I look for?
A: Obviously, it’s very difficult to predict corrections or market crashes when we consider the large number of failed predictions over the past years. That said, it is clear a financial crisis will come again and we find that there are three helpful areas to monitor when it comes to gauging the level of overall market risk: 1) leading economic indicators, 2) financial stress measures, and 3) various inter-market relationships. Some may be tempted to add geopolitical events or other factors to this list, but we would categorize most things falling outside of these three as potential catalysts or shocks that cannot be predicted but measured relative to their impact to the underlying health of the financial system. If leading economic indicators, financial stress measures, and the relationships between various markets are stable, then shocks can be absorbed more readily. If there is deterioration in the above, then it is not only more likely that a shock or crisis will occur, but that, when one does occur, investor confidence may shift into a panic mode and lead to herd-like selling, which is often what you see in a major bear market. That said, our indicators are not at levels associated with the onset of a bear market of the likes we saw in 2000-2002 or in 2008-2009, though we continue to monitor and update our readers and listeners of potential risks and changes. For example, see our discussion from last week, "Financial Fault Lines in the Bond Market," by clicking here.
Q: You've been positive on blue chip dividend-paying stocks for some time now. Are you still positive on this area?
A: We turned publicly bullish in 2010 once it was clear that the Fed’s efforts at injecting liquidity and lowering rates near zero had stabilized financial conditions. We articulated our stance and reasons for doing so in a piece titled, “The Great Reflation,” (see article) which paid homage to J. Anthony Boeckh’s 2010 book of the same title. Though dividend-paying stocks were not the focus of that article, those that have been following Financial Sense since the late 90s know of our long-term value-investing philosophy and discipline, which, as with Buffett, tends to focus on highly stable, dividend-growth stocks with good brand names. That said, given the current low rate environment and our general belief that the Fed will be very slow to raise rates and withdraw liquidity from the market, we still see many blue chip dividend-paying companies as attractive for investors for multiple reasons: 1) they provide a stable and increasing source of income, 2) they tend to outperform as bull markets age, and 3), aside from tax-free municipals, dividends are taxed more favorably than interest earned from bonds. Given the above, that does not mean we recommend a blind "buy-and-hold" strategy (especially overvalued stocks near an intermediate or long-term peak in the market, i.e. tech stocks in 2000 or housing-, construction-, and financial-related stocks in the mid to late 2000s), but in actively looking for opportunities and raising cash when market conditions arise.
If you have any questions or feedback on the above, please feel free to contact us at fswebmaster[at]financialsense[dot]com.
