Separating financial illusion from reality
April 15, 2013
Whether you are looking for the right time to jump into the stock market, or simply thinking of changing savings accounts, planning your next financial move can mean deciphering a constant stream of economic and investment news. This often comes down to distinguishing which information represents economic reality, and which is more of an illusion.
Here are six widely followed economic indicators, along with an assessment of how much each represents illusion or reality.
1. New highs in the stock market
This is often an illusion. For example, the stock market reached new heights recently not on the strength of record earnings, but because interest rates are unnaturally low. Think about it: According to the FDIC, rates on savings accounts recently hit an average of 0.07 percent, and money market rates were barely higher at 0.10 percent. Those paltry interest rates are forcing more and more people to consider the stock market, but if rates returned to the 4 or 5 percent range, much of this support for the stock market would disappear -- unless company earnings had strengthened.
2. Company earnings
That must mean company earnings represent economic reality, right? Yes, but with a couple of reservations. Earnings gains driven by top-line sales growth are a sign of fundamental business strength. Earnings gains due to cost-cutting reflect one-time moves that often can be detrimental to future top-line growth.
3. Consumer spending
Right now, this is an illusion. Yes, it represents actual economic activity, but too often with borrowed money. In a normal economic slump, getting people to spend, even by borrowing, is a good way to jump-start a recovery. However, in January 2013, total consumer debt outstanding reached a new all-time high. Until employment and earnings start going up, spending gains based on continued borrowing by over-extended consumers should be considered an economic illusion.
4. Consumer confidence
An illusion. Though consumer confidence figures are dutifully reported by just about every news outlet, the truth is that consumers are often confident right before things turn sour, and nervous when things are about to get better.
5. Weekly unemployment claims
Another widely reported figure that is more illusion than reality. First, weekly numbers are just too volatile to be of much use. Second, employment claims sometimes rise when the economy is getting better, as people who had previously given up trying to find work re-enter the labor force.
6. Monthly job creation
This is a pretty good indicator of reality. To be sure, the job creation numbers can give a false signal in any given month, but longer-term trends in jobs indicate whether new money is actually coming into the economy.
The difficulty of separating illusion from reality is one reason why there are both buyers and sellers in the market on any given day. It's also important to remember that illusions might dominate popular perception for weeks or months at a time, but the more you can keep your focus on reality, the sounder your financial decisions will be in the long run.