To quote Warren Buffett: “If you knew what was going to happen in the economy, you still wouldn’t necessarily know what was going to happen in the stock market.”
The economic cycle sees a constant stream of news. Various data are released on a recurring weekly, monthly and quarterly cycle. Sometimes they improve; sometimes they degrade. These are minor and noisy fluctuations, often reflecting flaws in how the data are collected or seasonally adjusted.
There are many reasons why economic data are so noisy, none of which matter to the primary driver of your investments, namely corporate profits and equity valuations.
Let’s look at Friday’s employment situation as an example: Most traders consider the nonfarm payroll release to be the single most important economic data of the month. But consider what it is that is actually being modeled. There are about 150 million Americans working full time. Each month, between 3 million and 4 million leave those jobs; another 3 million to 4 million start new ones. What the monthly employment situation report measures, in very close to real time, is the change in that number. You take the total number of new hires, subtract the total number of job losses, and that leaves the marginal net change in employment.
Given that the starting number is so big and the monthly net changes are so small, the overall change is almost statistically irrelevant — most of the time, less than 0.1 percent.
But wait, there’s more. That number gets revised as data are updated later in the year. It is revised a second time when a benchmarking is done sometime after that. Suffice it to say that the final revised, benchmarked employment number often looks nothing like the original release. (They don’t call them estimates for nothing.)
Thus, any single 0.1 percent data point needs to be recognized for what it is: one data point in a much longer series.
What I actually watch the data for are signs that the primary trend may be undergoing a significant change, such as an expansion reversing, suggesting a possible contraction. Since World War II, there have been 12 economic recessions — one about every five and a half years on average. Minor recessions (i.e., 1990) tend to drive stock prices down 20 to 30 percent, albeit temporarily. These downturns create good buying opportunities, as they allow long-term investors to make equity purchases at attractive valuations.
Consider: Even though more than half of the 41 OECD nations are currently in a recession, the present cyclical bull market dating back to March 2009 is the sixth-best rally since 1929.
As the statistician George Box put it three decades ago, “All models are wrong, but some are useful.” Hence, we pay attention to them only when they are warning us of a major shift in the overall trend, and ignore the weekly or even monthly fluctuations.