Economic Business Cycle and Earnings

Data from the Federal Reserve of New York, the same info that the Federal Reserve analyzes to set policy, on the current state of the US economic business cycle is analyzed. As an economy recovers from a bottom stage; industrial production should increase, inventory should decline, and commodity prices should increase. This data is critical to an investment strategist that uses a strategy involving the economic business cycle.

The industrial production data shows that production, which had a very severe decline in 2008, has started to recover. This means that people and other businesses have increased spending. A positive sign.

The inventory data shows a buildup during 2008 and early 2009 that is starting to decline. With increased spending business inventories will decline. Inventories go up as business slows down and vice versa as most businesses sell product through a distribution system. Another positive sign.

The commodity data shows that prices are also starting to increase. This is expected as demand increases for commodities based upon the law of supply and demand. Another positive sign.

What is the bottom line of this data? The economy has moved from the bottom stage to an early growth stage. For an investor, you want to maintaim your current position of owning: stocks, mutual funds that invest in stocks, short term bonds, and avoid long term bonds.

Earnings season is upon us once again and this past week some earnings were reported. It was reported that most companies were reporting better than expected earnings which surprised many experts, so much for expert opinion. Improved earnings are favorble for the stock market and stock market indexes around the world went up last week.

For what it is worth, I will give you my opinion that this trend of better than expected earnings should continue for the rest of this quarter. This should continue to support the stock market. The main reason is that companies project earnings, in a conservative manner, based upon the business conditions that exist at the time of the announcement. Since business conditions improved during the quarter it should also lead to improved earnings. This normally happens as the economy is growing.

When a publicly traded company gives earnings guidance it tends to be conservative in nature for a few reasons including: it is impossible to predict the future and if you miss the earnings number the stock price will drop and executives can lose their job. It is done to manage expectations of the major investors such that if you beat the earnings number you look like smart and if you miss it you look incompetent. The #1 objective of the CEO and Board of Directors, besides keeping their job, is to increase stock price.

I look forward to watching the earnings reports during the next 4 - 6 weeks.