Introduction to economic activity

Text 11

STOCK MARKETS

Text 10

Today the S&P 500 has a 19 PIE and a 2% dividend yield. It's not as cheap as it was 55 years ago. But does that mean that stocks are a bad buy? No. The current market is different in that it is the first bull market in the last half-century where multiples have contracted. At the start of this bull market in October 2002, the market P/E was 27. Stocks have since climbed, yet multiples are down because earnings have climbed even faster.

My firm recently analyzed the market's reaction to three dozen monthly economic indicators and found that the ones with the greatest effect are not those that measure the economy, inflation or monetary conditions. Rather, the sharpest moves come from sentiment measures such as consumer confidence.

Technical analysis doesn't offer much help here. Technicians, noting the strength in the advance-decline line lately, have forecast at least six more months of higher prices. Of course, when more stocks are advancing than declining it is a bullish signal. These same worthy souls apparently have forgotten the lesson of 1999, when they argued that the market was going down because that indicator was negative; the S&P ended that year with a 19% gain. My hint on the advance-decline line is that within a bullish climate it tends to peak 12 months before the market. No one can tell when it is peaking until afterward, though.

Economic activity began with the caveman, who was economically self-sufficient. He did his own hunting found his own shelter, and provided for his own needs. As primitive populations grew and developed, the principle of division of labour evolved. One person was more able to perform an activity than another and therefore each person concentrated on what he did best. While one hunted, another fished. The hunter then traded his surplus to the fisherman, and thus each benefited.

In today's complex economic world, neither individuals nor nations are self-sufficient. Nations have utilized different economic resources; people have developed different skills. This is the foundation of world trade and economic activity. As a result of this trade and activity, international finance and banking have evolved.

For example, the United States is a consumer of coffee, yet it does not have the climate to grow any of its own. Consequently, the United States must import coffee from countries (such as Brazil) that grow coffee. On the other hand, the United States has large industrial plants capable of producing a variety of goods, which can be sold to countries that need them.

If nations traded item for item, such as one automobile for 10,000 bags of coffee, foreign trade would be cumbersome and restrictive.

But instead of barter, which is the trade of goods without an exchange of money, all countries receive money in payment for what they sell. The United States pays for Brazilian coffee with dollars, which Brazil can then use the wool from Australia, which in turn can buy textiles from Great Britain, which can then buy tobacco from the United States.

Foreign trade, the exchange of goods between nations, takes place for many reasons such as: no nation has all the commodities that it needs, a country often does not have enough of a particular item to meet its needs, and one country can sell some items at a lower cost than other countries.

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