For millions of Americans>, watching and waiting is the new day-trading-and the trillion-dollar question is when they'll feel fully comfortable investing in stocks again. In the U.S. alone, investors still have nearly $900 billion parked on the sidelines, according to Thomson Reuters. The tide finally began to shift this spring, when an upward bounce in the markets and upbeat forecasts from luminaries like Federal Reserve Chairman Ben Bernanke helped lure some investors out of hiding. Financial advisers say they're seeing a surge of inquiries from clients about stocks. "It's about 15 to 1 in terms of calls from people who want in versus out," says Tom Hepner of Ruggie Wealth Management. And sentiment among fund managers recently shifted from "apocalyptically bearish to reluctantly bullish," according to a survey by Banc of America Securities-Merrill Lynch.
The key word, though, is "reluctantly." The recent rallies have eased some investors' fears, but it will take a lot more prodding for others to get over the crash of 2008. Although the pros know that historically, stocks recover long before the rest of the economy, nobody wants to suffer more losses by getting in too early. Or, for that matter, too late: Some who missed out on this spring's stock gains now fear that the market has no more gas in the tank. Misgivings like these explain why pros and amateurs alike obsess over their favorite economic indicators-from "TED spreads" (it's a bond thing) to taxi-line wait times-trying to decide if the glimmers of improvement can translate into a lasting recovery.
With that in mind, SmartMoney magazine polled a slew of economists, managers and strategists to find out which signals will give them confidence that the worst is truly behind us. No single one of these indicators is a surefire green light. While any number of statistics-like weekly unemployment claims and surveys of sentiment among manufacturers-have helped to signal rebounds from the 10 recessions since World War II, few have hit the mark each time. TD Ameritrade Chief Investment Strategist Stephanie Giroux says that before she utters the words "a new bull market," she needs to see "clear evidence on multiple fronts that the economy is starting to grow again." For investors still smarting from last fall, waiting for multiple "go" signs has an appealing logic. Before they feel confident about the stock market's risks, they want to feel like the other elements of their economic lives are secure.
This spring, the S&P 500 rose more than 30 percent, confronting investors with a familiar conundrum: Was this a sucker's rally, or a long-lasting upturn?
To answer that question, some analysts looked beyond short-term price increases to study what they call the market's breadth. Jeff Rubin, director of research for Birinyi Associates, says that when rallies are broad-when they involve more than one sector of the economy-they're more likely to forecast a more sustainable bull market and an overall turnaround. Rubin points to rallies in 1975 and 1982 that turned out to be harbingers of bigger recoveries that followed. The good news is, this spring's rally was encouragingly broad. Indeed, according to data from research firm Morningstar, 10 of the 12 main industry sectors saw their stocks rise during that three-month stretch, with sectors like consumer services, industrial materials and media leading the way. The surge also stands in sharp contrast to an earlier, narrower rally from November through January, which focused mainly on financial stocks-and didn't last. If Rubin's historical pattern repeats itself, investors have reason to feel optimistic.
Thinking about breadth can also help investors ride out a downturn-because when a stock decline is "narrow," that's good news for stocks. This March, the major stock indexes hit 10-year lows. But as Paul Hickey, cofounder of the money-management firm Bespoke Investment Group, points out, only 36 percent of individual stocks reached new lows-a sharp contrast to last October, when 80 percent of stocks had that ugly distinction. The March figure was a sign that, instead of throwing the baby out with the bathwater, sellers were making reasonable decisions, company by company, says Liz Ann Sonders, chief investment strategist at Charles Schwab. And that suggests an absence of panic and a healthier climate for stocks.
Many money managers would rather base their get-back-in decisions on a more traditional measure-whether stocks in general are cheap. To gauge this, investors often rely on the price/earnings ratio, which compares a company's stock price to its profits. But Charles de Lardemelle, a relatively bearish value investor and comanager of the IVA Funds, says the ratio can be deceptive, because it doesn't let investors judge profit trends over time. He prefers to compare corporate profits to the U.S. gross domestic product, which measures the total output of the country's economy. Profits currently stand at 7 percent of GDP; de Lardemelle expects the figure to get down to 4 percent before the economy and the market see the potential for a sustained turnaround.
What to watch: Stock prices across different sectors of the economy.
Where to get them: http://news.morningstar.com/stockReturns/CapWtdSectorReturns.html
Bonds never get much respect from the public and the media, even though, at $25 trillion, the American bond market dwarfs the value of all U.S. stocks combined. The pros know better-in fact, they see bonds as the canary in the economic coal mine. The bond market basically represents a huge chunk of the money that gets borrowed by governments, businesses and consumers. When a company like General Electric needs to raise money, for example, it sells bonds to everyone from hedge funds to banks to ordinary Joes. When the economy gets shaky, bond buyers get nervous; they demand higher interest rates, and some borrowers can't raise money at all, in what we've all painfully come to know as a credit crunch. And all this happens long before stocks or the broader economy hit the skids. In the most recent crash, some of these credit signals started flashing red as early as the summer of 2007, even though the Dow was climbing toward a record high at the time.
Since lending, as some economists say, is the "mother's milk" of the economy, the pros are obsessively watching the bond markets for any hint that these problems have thawed. It's a good sign if companies can sell new bonds-what bankers call "issuance." Last fall corporate issuance ground to a halt, says Kevin Flanagan, fixed-income specialist for Morgan Stanley Global Wealth Management. But things have started to move again this year, as Xerox, Pfizer and other companies have brought out new bonds.
Many smaller business loans don't involve the public bond market, so investors also watch the Federal Reserve's Loan Officer Survey, which tracks loans for plants and equipment. Commodity-related stocks tend to move upward about nine months after bank lending improves, says Citigroup Chief Investment Strategist Tobias Levkovich. But any movement on any of these fronts suggests that businesses can get the money to expand and hire-the kind of turnaround the economy and stock investors are desperate for.
Lower interest rates are supposed to encourage borrowing. But low rates alone hardly guarantee a rebound-after all, many U.S. rates have been near record lows for months now. Instead, market watchers pay attention to "spreads," the differences between the interest on supersafe Treasury bills and the rates on other kinds of loans. The most closely watched ones include spreads based on corporate bonds, as well as the "TED spread," which compares Treasurys with the rates banks charge each other. Most such spreads drastically widened last year and are still unusually high; the pros will feel more confident about investing when they get narrower.
What to watch: The "TED spread." It recently fell to around 50 basis points, close to its historical average-an encouraging sign.
There's probably no sign of the economy's health that's more closely watched than employment. Most companies begin to rehire only once they are confident the worst economic news is behind them. That often doesn't happen until months after the market has turned around, so job numbers won't help an investor catch the early edge of a rally. But for someone looking for signs of a sustainable recovery, they're a useful gauge.
Economists and strategists pay particularly close attention to weekly unemployment-insurance claims-the number of people actually applying for employment benefits each week. When that number stops growing or even declines over a couple of months, it'll be a signal that the negative economic cycle is winding down, says Mark Zandi, chief economist at Moody's Economy.com. But investors who wait too long are likely to miss a rally. Traditionally, layoffs and other job losses keep rising even after the economy turns around, as employers adjust to new economic conditions. After recessions in 2001 and in 1961, job losses continued even after the recession had ended, says Birinyi researcher Rubin.
Job watchers also follow Labor Department stats that track demand for temps and the length of the average workweek, which reflects workers logging more overtime; an increase in either could be a glimmer of a turnaround. Once job losses begin to slow, Federated market strategist Phil Orlando thinks investors will shed the hunker-down mentality and buy growth-oriented stocks, including shares in energy companies.
New hiring won't be the only sign that American companies are ready to spend and grow again. Brian Bethune, economist at IHS Global Insight, watches the prices that used commercial vehicles and construction equipment are fetching, either on eBay or at auction houses-he says it gives him a quick window on whether companies are feeling bullish. The pros also keep an eye on the monthly report from the Institute for Supply Management, which surveys purchasing managers in 20 industries who buy such varied items as cables, computers, packaging boxes and machinery. In the institute's survey, a number over 50 suggests the economy is expanding; lately, it has hovered in the low 40s. Once it creeps back to 50, Orlando says he would buy industrial firms like General Electric.
Of course, anecdotal evidence matters, too. For Barry James, the president of the James Advantage mutual funds, attending religious services hasn't been entirely uplifting of late. On most Sundays over the past year, James has left his church outside Dayton, Ohio, burdened with news of yet another batch of job losses among his fellow parishioners. On the other hand, he figures that when the Sunday finally comes that he doesn't hear about layoffs, "it'll be the first real sign the economy is stabilizing." And better yet, of course, will be that Sunday when he starts hearing about his neighbors' new jobs.
What to watch: Weekly unemployment claims. Look for a couple of months of slower growth or, better yet, declines.
Where to get them: Department of Labor.
The drying up of consumer spending is one of the main reasons for today's recession, and even 50-year-low mortgage rates and rock-bottom prices at the mall haven't been enough to get Americans to open their wallets. "There is a loss of faith that distinguishes this downturn; people have gone to the bunker," Zandi says. That's why any sign that Main Street's pessimism about homes, jobs and futures has turned to optimism will be a major step in the recovery. Experts are keeping a close watch on surveys of consumer confidence like the monthly one put out by the Conference Board; a score of more than 50, like the one reported for May, suggests that consumers are more upbeat.
Other analysts, however, think that spending won't recover until Americans chip away at the huge piles of debt they accumulated over the past decade. According to the most recent figures, the average household's debt, including mortgages, sits at 235 percent of income-meaning a family with $100,000 in income has $235,000 in debt. Giroux, of TD Ameritrade, thinks that level will need to settle into a range between 170 and 200 percent before the economy starts consistently growing again. At that point, some pros say they'll be ready to invest more aggressively in retailing and leisure stocks.
To spot early signs of a rebound, many economists keep tabs on the Economic Cycle Research Institute's index of economic growth, which measures a slew of spending categories that include the mundane, like inflation, and the unusual, such as prices for tallow for the soap used to clean factories. In recent months that index showed a "pronounced, persistent and pervasive" recovery, says Lakshman Achutan, managing director of the institute, who thinks the recession very likely will be over by the end of summer. History is on his side: Since the late 1930s the index has reliably spotted a recovery an average of four months before the end of each recession.
What to watch: Consumer confidence index; two or more months in a row with scores above 50 would be good news.
Where to get it: The Conference Board business trade group.
Since there was a housing bubble at the epicenter of this financial crisis, it's natural to look to the real estate market for signs the worst is over. After all, if people are willing to buy homes, it suggests they feel pretty good about their jobs and future prospects-all positive signals for a sustainable stock run. But it's not as easy as counting how many people are visiting the open house next door, or even counting home sales, where figures were inflated this spring by a record number of homes being sold in foreclosure.
So where are economists looking for a welcome mat? For starters, they'd like to see more stability in home sales and prices. Since there's still a glut of homes sitting empty, experts suspect it will be some time before prices start rising meaningfully. To try to spot the home-price bottom, Giroux is keeping her eyes on the trends in existing home sales. Many homeowners are currently opting to stay put rather than join the fire sale of foreclosed homes, but once they feel comfortable enough putting their homes on the market, it'll be a sign the housing situation is on the mend. It'll be another good sign when housing starts and building permits increase after a long decline-that will suggest developers finally feel they can make money on new buildings again.
Despite a market full of bargains, Americans have had a hard time overcoming the psychological hurdle of buying a home amid uncertain financial times. But if they're looking for an excuse to turn the corner, they might be encouraged by housing-affordability indexes like the one maintained by the National Association of Realtors. Those indexes compare home prices with local incomes and mortgage rates, and in many areas of the country, they show that buying now makes more economic sense than renting. Housing affordability typically improves like this about two quarters ahead of revivals in investment in real estate, according to Ed Yardeni, chief investment strategist at Yardeni Associates. Another encouraging sign: The Consumer Sentiment index, issued by Reuters and the University of Michigan, recently found that 70 percent of respondents thought it was a good time to buy a home, up from a low of 57 percent in 2006. "I think we are seeing a bottoming process," says Stephen Kim, senior analyst at Alpine Global Real Estate fund.
What to watch: Housing starts and building permits. The more, the merrier.
Where to get it: The Census Bureau's New Residential Construction index.