Indicators Still Flash Green

04/18/2007 12:00 am EST


David Fried

Editor, The Buyback Letter

David Fried, editor of The Buyback Letter, says that seven indicators he uses to track the market still look “mildly positive.”

Underneath the market noise are solid realities that ultimately rule the day.

Big Trend #1: Inflation. Since 1920, the Standard & Poor’s 500 index has gone up an average of 15.5% when inflation was in the 2%-5% range. When inflation topped 5%, the S&P average rose just 1.3% per year. Currently, inflation is running well below 5%.  The inflation indicator remains positive.

Big Trend #2: Bond yield. Peter Lynch, the famed manager of The Magellan Fund during its glory days, said when yields on long-term government bonds exceed the yield on the S&P 500 by six percentage points or more, sell stocks and buy bonds. The current difference between the two yields is 2.95%. So the dividend yield indicator remains positive.

Big Trend #3: Federal Reserve. After 17 consecutive short-term rate increases the Fed has ended its bias toward rate hikes. The Fed Indicator is neutral.

Big Trend #4: Yield curve. Currently the yield curve is partially inverted. The short-term yield is inverted compared to the 10-year note but not the 30-year bond, while the relationship of the ten-year to the 30-year yield is in order. The yield curve indicator is neutral.

Big Trend # 5: Valuation. The increase in the market so far this year did not increase the P/E ratio of the S&P 500 as earnings have increased as well. The S&P 500 trades at about 17.6x earnings, a lower P/E than we have had since the late 1990s. The valuation indicator is neutral.

Big Trend #6: Investor sentiment. We add the total bullish percentage readings of Investors Intelligence, Consensus Index, AAII Index and Market Vane and average this figure for the month. We consider an average reading of more than 200 to be negative while readings of less than 150 are positive. The average total reading for the month ending March 31, 2007 is 203. So the sentiment Indicator is negative.

Big Trend #7: Money supply. The broadest measure of money supply available is called M2, Currently, M2 is $7.1 trillion, up from about $6.96 billion at the same time last year. An expanding money supply is bullish for equities, but this is a very mild expansion. M2 Indicator is neutral.

After a rise of 26% in 2003, 9% in 2004, 2.9% in 2005 and 13.6% in 2006%, the market has regained most of the losses following the 2000 peak. Two of our seven indicators are positive (inflation, dividend yield), one is negative (sentiment) and four are neutral (valuation, Fed, yield curve, and M2). Our indicators are telling us the investment climate is still mildly positive at this time.

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