Good News Has Arrived for Investors

I'm happy to report that my very favorite macroeconomic indicator has turned positive. I'm not talking about Friday's surprisingly not-bad jobs report. It's something I like even more.

It's my favorite because it has nothing to do with macroeconomics, and it is based on analysis that is always wrong. And yet, it works.

I'm talking about consensus forward earnings for the stock market. That means taking all the Wall Street analysts' guesses for earnings one year in the future for whatever companies they happen to cover, averaging them, and then capitalization-weighting them so you get the aggregate consensus for the whole S&P 500.

No analyst's estimate for a particular company is a forecast of the overall economy. It may take the economy into account in some way, but it's mostly just a forecast for what a single company will do.

And as we all know, Wall Street analysts are almost always way off target. They're generally way too bullish. And a lot of people believe they're corrupt, as well, giving flattering appraisals of companies that their investment firms would like to do business with.

But it turns out that when you average them all together, their errors and their biases cancel out. And in the aggregate, they can be used as a bottom-up view forecast of the whole economy.

And it works. Turning points in aggregate consensus forward earnings for the S&P 500 -- that is, when they've stopped growing and started falling -- have perfectly forecasted the last three recessions, including the current one.

And when they turned up, they perfectly forecasted the recoveries from the last two recessions. The great news is that they're on the very verge of turning up right now. It's just a matter of days.

They've already turned up if you take out the damaged financial sector. But even including that problem child, they're improving fast. Again, it's just a matter of days.

Let me be clear about what this means. In October 2007 -- within days of the all-time top for stocks -- aggregate forward earnings started to turn down. It was a perfect sell signal. But at first, all it really meant was that the 500 companies in the S&P 500 were expected have their earnings grow more slowly than had been expected before.

In July 2008, it got worse. Within weeks of the onset of the worst of the global banking crisis, aggregate forward earnings suddenly deteriorated so badly that they were forecasting outright lower earnings, not just more slowly growing earnings. Again, it was a perfect sell signal -- a week or two later, the wheels came off the global economy, and the stock market.

Three months ago, within days of the bottom in stocks, aggregate forward earnings started to turn around. It was less than a ringing endorsement at first. It just meant that the decline in earnings was now expected to get less bad -- not that earnings would actually grow. But it was a perfect buy signal.

And now aggregate forward earnings are on the verge of forecasting that earnings growth is back. It's a buy signal. And if the pattern holds, it will be a good one.

It comes at a critical time in markets. The S&P 500 is brushing up against a major downtrend line, the one that defines this terrible bear market. Friday morning, stocks opened up through that line in a major gesture of technical strength. But as of this writing an hour into the trading session, stocks have fallen back.

I think stocks are being appropriately skeptical, even though experience and logic both compel me to believe strongly in the forward earnings indicator. Things just seem so rotten in the economy, it's hard for me to believe that even if we do break out of this bear market, the bull market to come may not be all that exciting.

After all, the forward earnings indicator -- assuming that it actually goes fully positive as I expect it will over the next several days -- will be the only macroeconomic indicator that is giving a real buy signal. All the others are still where the forward earnings indicator has been for the last three months -- that is, just saying that things are getting less bad, not that they are getting good.

For example, look Friday's jobs report. A loss of 345,000 jobs in May is an improvement. It's the smallest loss in many months. That's good. But it's not great. It's still a huge loss.

And I am very concerned that some of the extreme responses to the crisis of the last year -- all the government bail outs and stimulus, and the Federal Reserve's extraordinary monetary easing -- will have hangover effects that will hold the economy back for many years.

Someday we're going to have to pay back all the debt we've run up over the last year, and that means higher taxes. Not good for growth. And someday we're going to have a lot of inflation as the result of the Fed's ultra-low interest rates, and the historic growth of its balance sheet. Not good for growth.

But on the other hand, stocks fell very, very hard from the October 2007 top to the March 2009 bottom. And so far they've rallied from that bottom less than 40 percent. Even in the Great Depression we had a 50 percent rally in stocks. So there's no reason why stocks can't bounce back some more, for no better reason than relief.

So call me a cautious bull. I now have almost no doubt that the recession is over. I am very confident that stocks won't make new lower lows in this cycle. So at the very least, I can conclude that there's more room on the upside than on the downside.

And I can't ignore the fact that my favorite indicator is giving a buy signal.

My favorite way to play it continues to be what I've been recommending here for months -- stocks that benefit from inflation. My own personal favorites are small-cap metals companies, involved in mining gold, silver and platinum.

That way I get to exploit the good news of economic recovery, and at the same time exploit the bad news of inflation.