The Only Indicators You'll Ever Need
With these five keys to the market's direction, your stock strategy can't stray off course.
By Christopher Graja and Elizabeth Ungar Bloomberg Personal Finance January/February 2001
One can never be too rich or too thin, the late Duchess of Windsor reputedly said. Maybe, maybe not.
But an investor can be too informed. Every month, scores of economic and business statistics are
released, and while each has merit, anyone who tries to digest them all will have no time left to invest.
The 40th piece of data adds little that can't be gleaned from the first 39. In fact, you can get most of
the information you need to map out basic stock strategy by following just five market indicators.
Of course, you must choose the right five. They should be unbiased and impossible to manipulate, and
they should reflect investors' actions rather than their words. They should also be proven performers
that have been thoroughly studied and used by market professionals with credible records. We have
selected five that are essential for investors in U.S. equities because they measure factors crucial to
success in that market: Three pertain to sustainability of growth (in both earnings and the economy),
one to valuation, and one to sentiment. These five indicators-- particularly when considered in
combination--provide signals that will help you tweak your equity allocation, determine which styles to
favor and which sectors to under- or overweight, and how aggressive or cautious you should be in
One of the quickest and easiest ways to get a handle on future economic growth is to study the slope
of the Treasury yield curve. The curve plots Treasury yields against a range of maturities, from 3
months to 30 years. Its slope--the difference, or spread, between the 10-year and 3-month yields--
indicates the bond market's expectations about the future course of the economy. The curve's normal
slope is gently positive (slightly higher at the long than at the short end), reflecting the fact that
bondholders generally demand higher rewards to compensate them for the higher risks associated
with longer holding periods.
The longer the maturity, for instance, the more danger there is that inflation will erode the purchasing
power of the coupon payments and of the principal when it is returned. A steeper curve signals
expectations of an accelerating economy that could spark inflation, pushing up longer-term yields; a
flatter curve means few inflation qualms and the expectation of only moderate growth. An inverted
curve, where 3-month bills yield more than 10-year notes, signals recession. Last year, the yield
spread dropped steeply, from a high of about 130 basis points (1.3 percent) in January to a low of
about -74 basis points in late November, reflecting expectations of an economic slowdown.
Equities in general do better in expansions than in recessions. Corporate earnings, after all, drive