Trailing Indicators and Economic Recovery

Following the Trailers

An Aged Visitor

Mayfly or The Next Big Thing

It’s easy to understand what a leading economic indicator is and why it leads.  If purchasing managers are increasing their buying, it’s because their businesses need new equipment to do business with.  Increasing consumer confidence will lead to more consumer spending.  Simple.

Trailing indicators are a little more complicated, and the amount of attention being paid at the end of last week to layoffs, initial unemployment claims and the unemployment rate are a great illustration.

Last Thursday, initial claims for unemployment benefits dropped by 38,000 to 550,000.  (There’s a lot of massaging done to these figures to compensate for predictable seasonal fluctuations.)  That may seem like a lot of new people hitting the unemployment rolls, but the really important statistical tidbit is that analysts had expected 580,000 new claims.  a

Then last Friday, the figure for July job losses in the U.S. was released, and the number fell from the June level of 443,000 to 247,000.  Again, economy watchers had expected the number to decline, but were expecting a higher figure of 320,000.  The headline unemployment rate also dipped from 9.5% to 9.4%, while analysts had forecast 9.6%.

Now for most of us, a 9.4% unemployment rate and 550,000 new names applying for unemployment seems like bad news even if analysts were predicting higher numbers for both.  But that brings us back to why employment is a trailing economic indicator and what that means for stock investors.

For historical perspective, let’s go back to the last big market decline, the one that followed the bursting of the Tech Bubble in 2000.  The market topped out in January of that year, and in that month unemployment fell to 4.0%, its lowest level since January 1970!  As the market began its torturous decline, unemployment remained at those historically low levels, making it all the way through 2000 within a tenth of a percent of that reading and finishing the year with three months of unemployment at 3.9%.

Note that unemployment rates actually went down for 12 months following the market high.

Both the Dow and the S&P 500 bottomed in October 2002 (October 10, for those of you with a taste for exact dates), when unemployment rates were in their third month of registering 5.7%, not bad by historical standards, but well up from their 3.8% low in April 2000.  Unemployment continued to creep up, even as the stock market was getting back into gear, and the rate actually peaked at 6.3% in June 2003, eight months after the market low. 

Why does this happen?  What is it that keeps joblessness high and produces headlines about a “jobless recovery?”  You have to put yourself in the position of a CEO to understand. 

When recessions hit, CEOs respond to lower demand for products and services by laying people off.  (They may think of it in terms of lowering costs, but generally speaking, firing people is one of the first items on The Frugal CEO’s To-Do List.)  And the earlier and deeper the job cuts, the better the bottom line.

But when the recovery comes, the last thing the successful company head wants to do is to get ahead of it with hiring.  Economic downturns are fragile, and weathering an economic whipsaw with an expensive group of inexperienced new names on the payroll can be risky.

So the successful business fires early and hires late, when the risk has diminished enough to make it worthwhile.

That’s what makes unemployment a trailing indicator.  The same impulse that pushed it up in the first place keeps it up until the recovery of the economy is a proven fact.

So when you see the headlines announcing that unemployment has stopped growing, you’re actually seeing a big billboard trumpeting the onset of a full recovery of the economy.

Equity markets knew that months ago, which is also traditional.  The parade of economic recovery always proceeds in the same order.  The equity markets lead the way, the economy follows, and employment always trails months behind.

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My wife and I are getting ready for a visit from her 92-year-old father and her brother.  They’re coming up to escape the heat in Tulsa, Oklahoma, which has been recording one scorcher after another.

It will be fun to have them with us for a nice 10-day visit, although a 92-year-old house guest requires more than a usual amount of preparation.

I’d say that Bill, my father-in-law, is near the top of his class in terms of mobility, mental acuity and sense of humor.  He still drives his own car, lives in his own house, and pays his own bills, which is definitely something to shoot for in one’s ninth decade.

I’m writing about him for two reasons.

The first is that he’s a great example of the joys of a big-company retirement plan.  He worked for an oil company just about his whole career and has been enjoying the income and health coverage (and dividends from his company stock) for more than two decades. 

It’s exactly the kind of coverage that American companies have been trying to get rid of as they work to reduce costs in an increasingly globalized economy.  But I’m convinced that it has given my father-in-law more years and more good years of life.

As the U.S. hotly debates whether and what kind of national health plan to adopt, I can only hope that more people will gain the peace of mind and health benefits of paid health coverage. 

Second, I’m writing because Bill has only owned one stock in his life, and it’s the one that he bought through his company stock plan.  Since the year 2000, the stock has traded as high as 80 and as low as 35.  It’s now right about in the middle of that range, trading just above 50.  But it has paid its dividend faithfully, with a trailing annual dividend rate of 6.6%.

I’ve talked to him about diversifying a bit, but his resolute refusal to mess with what’s working looks pretty good right now.  The stock lost half of its value in the Great Bear of 2008, but if you’re not selling, that’s not really relevant.  The income stream is fine with him.

For those of you for whom the buy-and-hold-and-hold-and-hold-and-hold strategy doesn’t offer the potential payout you’re looking for, I might suggest one of Cabot’s growth stock investing letters.  Cabot China & Emerging Markets Report recommends stocks that would give my father-in-law a hissy fit, but for active growth investors, there aren’t many hotter choices.  It has the top risk-adjusted returns for the past five years of any investment newsletter, and it’s been on a very good run in recent months.  You can get a risk-free trial subscription by clicking on the link below.

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For my investment idea today, I’ve deliberately headed toward the low end of the price scale.  Xinhua Sports and Entertainment Limited (XSEL) is so low-priced (less than 2) and trades such low-volume (it averages less than 200,000 shares traded per day) that it’s too volatile for even an aggressive growth advisory like Cabot China & Emerging Markets Report.

But the company’s strategy is innovative–it has developed an integrated platform of advertising resources that includes TV, Internet, cell phone, radio, newspapers, magazines, university campuses and other outlets.  The company’s broadcast arm sells advertising and produces content for radio and TV.  The print division owns advertising rights for two Chinese magazines and one newspaper. And the advertising plans, creates and places ads on Web sites, on TV, in print, on radio and on campus billboards and outdoor media.  It controls the rights to the All Sports Network in China, produces a reality TV show called The Scene, which looks at ordinary urban Chinese, and produces the Fortune China financial TV shows.

It’s hard to say just how solid this company is.  It was incorporated in November 2005, and management has negotiated some valuable placement rights and secured the rights to some desirable content.  Earnings have been positive since 2005, although year-over-year results have been in decline. 

The big draw for XSEL is its chart, which shows a stock that dipped as low as 22 cents a share last March, but had been steadily improving until July 27, when it took off like a rocket, gaining nearly 32% in one day.  Since then, the stock has continued to soar on elevated volume, and is rapidly closing in on 2.

XSEL traded at 13 when it came public in March 2007, but started declining almost immediately until it plunged deep into penny stock territory in March of this year.

I don’t really recommend buying XSEL.  It’s too much of a mayfly to risk your hard-earnings money on.  This enviable eight-bagger advance can make your mouth water, but except for the announcement of the company’s earnings report date and PR Newswire fluff, there have been no news stories on the company in months.  But it’s a fascinating story and the P/E of 7 is admirable.

The company’s Q2 earnings will be announced on Wednesday, August 12 at 8 p.m.  Then we’ll see what happens.

Sincerely,

Paul Goodwin
For Cabot Wealth Advisory

P.S. For those of you who enjoy looking at the night sky, I just want to remind you that the annual Perseid meteor shower will come around on August 11 and 12.  This is one of the most reliable of the annual meteor showers, sometimes producing up to 80 “shooting stars” per hour.  So put on your mosquito repellant, take the relaxing beverage of your choice to some dark spot and look toward the northeast where the lazy W of the constellation Cassiopeia lives and enjoy the show!  I’ll be sharing it with you.

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