For millions of Americans, watching and waiting are the new day trading -- and the trillion-dollar question is when they'll feel fully comfortable investing in stocks again.
In the U.S. alone, investors still have nearly $900 billion parked on the sidelines in cash, according to Thomson Reuters. The tide finally began to shift this spring, when a bounce in the markets and upbeat forecasts from luminaries such as Federal Reserve Chairman Ben Bernanke helped lure some investors out of hiding. Financial advisers say they're seeing a surge of inquiries from clients about stocks.
"It's about 15-to-1 in terms of calls from people who want in versus out," says Tom Hepner of Ruggie Wealth Management. And sentiment among fund managers recently shifted from "apocalyptically bearish to reluctantly bullish," according to a survey by Banc of America Securities-Merrill Lynch.
The key word, though, is "reluctantly." The recent rallies have eased some investors' fears, but it will take a lot more prodding for others to get over the crash of 2008. Although the pros know that historically stocks recover long before the rest of the economy, nobody wants to suffer more losses by getting in too early.
Or, for that matter, too late: Some who missed out on this spring's stock gains now fear that the market has no more gas in the tank. Misgivings such as these explain why pros and amateurs alike are obsessing over their favorite economic indicators -- from "TED spreads" (it's a bond thing) to taxi-line wait times -- as they try to discern if the glimmers of improvement can translate into a lasting recovery. (See "How your undies track the recession.")
1. Stock market moves
For investors still smarting from last fall, waiting for multiple "go" signs has an appealing logic. Before they feel confident about the stock market's risks, they want to feel like the other elements of their economic lives are secure. Here are five things worth watching.
This spring, the Standard & Poor's 500 Index ($INX) rose more than 30%, confronting investors with a familiar conundrum: Was this a sucker's rally or a long-lasting upturn?
To answer that question, some analysts looked beyond short-term price increases to study what they call the market's breadth. Jeff Rubin, the director of research for Birinyi Associates, says that when rallies are broad -- when they involve more than one sector of the economy -- they're more likely to forecast a sustainable bull market and an overall turnaround. Rubin points to rallies in 1975 and 1982 that turned out to be harbingers of the bigger recoveries that followed.
The good news is that this spring's rally was encouragingly broad. According to data from research firm Morningstar, 10 of the 12 main industry sectors saw their stocks rise during that three-month stretch, with sectors such as consumer services, industrial materials and media leading the way. The surge also stands in sharp contrast with an earlier, narrower rally from November through January, which focused mainly on financial stocks and didn't last. If Rubin's historical pattern repeats itself, investors have reason to feel optimistic.
Thinking about breadth can also help investors ride out a downturn. When a stock decline is "narrow," that's good news for stocks. This March, the major stock indexes hit 10-year lows. But as Paul Hickey, a co-founder of money-management firm Bespoke Investment, points out, only 36% of individual stocks reached new lows. That's in sharp contrast with last October, when 80% of stocks earned that ugly distinction.
The March figure was a sign that, instead of throwing the baby out with the bath water, sellers were making reasonable decisions, company by company, says Liz Ann Sonders, the chief investment strategist at Charles Schwab. And that suggests an absence of panic and a healthier climate for stocks.
Many money managers would rather base their get-back-in decisions on a more traditional measure -- whether stocks in general are cheap. To gauge this, investors often rely on the price-to-earnings ratio, which compares a company's stock price with its profits. But Charles de Lardemelle, a relatively bearish value investor and a manager of the IVA Funds, says the ratio can be deceptive because it doesn't let investors judge profit trends over time. He prefers to compare corporate profits with the U.S. gross domestic product, which measures the total output of the country's economy.
Profits currently stand at 7% of GDP. De Lardemelle expects the figure to get down to 4% before the economy and the market see the potential for a sustained turnaround.
What to watch: stock prices across different sectors of the economy.
2. Borrowing and lending
When the economy gets shaky, bond buyers get nervous; they demand higher interest rates, and some borrowers can't raise money at all, in what we've all painfully come to know as a credit crunch. And all this happens long before stocks or the broader economy hits the skids.
Because lending, as some economists say, is the "mother's milk" of the economy, the pros are obsessively watching the bond markets for any hint that the freeze is thawing. It's a good sign if companies can sell new bonds -- what bankers call issuance. Last fall, corporate issuance ground to a halt, says Kevin Flanagan, a fixed-income specialist for Morgan Stanley Global Wealth Management. But things have started to move again this year.
Many smaller business loans don't involve the public bond market, so investors also watch the Federal Reserve's Senior Loan Officer Opinion Survey, which tracks loans for plants and equipment. Commodity-related stocks tend to move upward about nine months after bank lending improves, says Tobias Levkovich, the chief investment strategist at Citigroup. But any movement on any of these fronts suggests that businesses can get the money to expand and hire -- the kind of turnaround the economy and stock investors are desperate for.
Lower interest rates are supposed to encourage borrowing. But low rates alone hardly guarantee a rebound; many U.S. rates have been near record lows for months now. Instead, market watchers pay attention to "spreads," the differences between the interest on supersafe Treasury bills and the rates on other kinds of loans. The most closely watched indicators include spreads based on corporate bonds, as well as the "TED spread," which compares Treasurys to the rates banks charge each other. Most such spreads drastically widened last year and are still unusually high; the pros will feel more confident about investing when they get narrower.
What to watch: the TED spread. It recently fell to about 50 basis points (half of a percentage point), close to its historical average, an encouraging sign.
Where to get it: many financial news sites, including TEDspread.com.
3. Business hiring and spending
Economists and strategists pay particularly close attention to weekly unemployment-insurance claims -- the number of people applying for employment benefits each week. When that number stops growing or even declines over a couple of months, it'll be a signal that the negative economic cycle is winding down, says Mark Zandi, the chief economist at Moody's Economy.com. But investors who wait too long are likely to miss a rally. Traditionally, layoffs and other job losses keep rising even after the economy turns around, as employers adjust to new economic conditions.
Job watchers also follow Labor Department statistics that track demand for temporary workers and the length of the average workweek; an increase in either could be a glimmer of a turnaround. Once job losses begin to slow, Federated Investors market strategist Phil Orlando says, he thinks investors will shed the hunker-down mentality and buy growth-oriented stocks, including shares in energy companies.
New hiring won't be the only sign that U.S. companies are ready to spend and grow again. Brian Bethune, an economist at IHS Global Insight, watches the prices that used commercial vehicles and construction equipment are fetching, either on eBay or at auction houses. He says they give him a quick window on whether companies are feeling bullish.
The pros also keep an eye on the monthly report from the Institute for Supply Management, which surveys purchasing managers in 20 industries who buy such items as cables, computers, packaging boxes and machinery. In the institute's survey, a number over 50 suggests the economy is expanding; lately, it has hovered in the low 40s. Once it creeps back to 50, Orlando says, he would buy stocks of industrial companies such as GE.
Of course, anecdotal evidence matters, too. For Barry James, the president of James Advantage Funds, attending religious services hasn't been entirely uplifting of late. On most Sundays over the past year, James has left his church outside Dayton, Ohio, burdened with news of yet another batch of job losses among his fellow parishioners. On the other hand, he figures that when the Sunday finally comes that he doesn't hear about layoffs, "it'll be the first real sign the economy is stabilizing." And better yet, of course, will be that Sunday when he starts hearing about his neighbors' new jobs.
What to watch: weekly unemployment claims. Look for a couple of months of slower growth or, better yet, declines.
4. The indomitable consumer
That's why any sign that Main Street's pessimism about homes, jobs and futures has turned to optimism will be a major step in the recovery. Experts are keeping a close watch on surveys of consumer confidence like the monthly one put out by The Conference Board; a score of more than 50, like the one reported for May, suggests consumers are more upbeat.
Other analysts, however, don't think spending will recover until Americans chip away at the huge piles of debt they have accumulated over the past decade. According to the most recent figures, average household debt, including mortgages, sits at 235% of income, meaning a family with $100,000 in income has $235,000 in debt. Giroux, of TD Ameritrade, thinks that level will need to settle into a range between 170% and 200% before the economy starts consistently growing again. At that point, some pros say they'll be ready to invest more aggressively in retail and leisure stocks.
To spot early signs of a rebound, many economists keep tabs on the Economic Cycle Research Institute's index of economic growth, which measures an array of spending categories, from the mundane, such as inflation, to the unusual, such as prices for tallow for the soap used to clean factories.
In recent months that index showed a "pronounced, persistent and pervasive" recovery, says Lakshman Achuthan, the managing director of the institute, who adds that he thinks the recession very likely will be over by the end of summer. History is on his side: Since the late 1930s, the index has reliably spotted a recovery an average of four months before the end of each recession.
What to watch: consumer confidence index; two or more consecutive months with scores above 50 would be good news.
Where to get it: The Conference Board, a business trade group.
5. Hopes for housing
So where are economists looking for a welcome mat? For starters, they'd like to see more stability in home sales and prices. Since there's still a glut of homes sitting empty, experts suspect it will be some time before prices start rising meaningfully.
To try to spot the home-price bottom, Giroux is keeping her eye on the trends in existing home sales. Many homeowners are currently opting to stand pat rather than join the fire sale of foreclosed homes, but once they feel comfortable enough to begin putting their homes on the market, it'll be a sign the housing situation is on the mend. It'll be another good sign when housing starts and building permits increase after a long decline, which will suggest that developers finally feel they can make money on new buildings again.
Despite a market full of bargains, Americans have had a hard time overcoming the psychological hurdle of buying a home amid uncertain financial times. But if they're looking for an excuse to turn the corner, they might be encouraged by housing-affordability indexes like the one maintained by the National Association of Realtors. Those indexes compare home prices with local incomes and mortgage rates, and, in many areas of the country, they show that buying now makes more economic sense than renting. Housing affordability typically improves like this about two quarters ahead of revivals in investment in real estate, according to Ed Yardeni, the chief investment strategist at Yardeni Associates.
Another encouraging sign: The Consumer Sentiment Index, issued by Reuters and the University of Michigan, recently found that 70% of respondents thought it was a good time to buy a home, up from a low of 57% in 2006. "I think we are seeing a bottoming process," says Stephen Kim, a senior real-estate analyst at Alpine Closed End Funds.
What to watch: housing starts and building permits. The more, the merrier.
Where to get it: the Census Bureau's New Residential Construction index.