Health of the American Economy Is Predicated

¶ … health of the American economy is predicated on favorable financial conditions. Economic indicators serve as a barometer of the country's economic health, which in turn can spell profits or ruin for most companies. Economic growth provides a template for investor expectations. If an investor notes that leading indicators, such as contracts for new home sales, are rising then he or she knows that a perfectly distributed index fund that reflects the performance of the entire market will grow in value.

Consumer behavior is largely correlated with national economic growth. If a consumer sees that the economy is doing poorly, she might be worried about her job and forego a vacation or the purchase of a home entertainment system. Alternately, she may still purchase a washing machine if the one she owns breaks down. Such a person might be tempted to pass over the Dom Perignon for Boone's Farms, or her usual Dunhill Cigarettes for Basic 100's. This has lead mutual fund managers to break down consumer goods into different investment sectors that reflect economic cycles, including consumer cyclicals, consumer durables, and counter-cyclicals. Consumer cyclicals are consumer goods that sell well during good times and take a beating during hard times, such as the home entertainment system. Consumer durables are largely immune to market fluctuations. Counter-cyclicals perform normally or better during hard times - these include down-market products such as fortified wine, economy-brand cigarettes or bus tickets.

Unemployment is important for several reasons. First of all, it is a general indicator of economic health. Whereas employed people buy new cars and computers, unemployed people are more likely to sit at home going over the help wanted section of the newspaper or hotjobs.com. Unemployment also decreases federal revenues while burdening the unemployment roles. The Federal Reserve will often lower interest rates in response to unemployment in order to encourage growth; companies are pleased because they can hire employees more cheaply and borrow at lower rates. However, interest rate levels are currently at an all-time low, which in turn has created what the Economist calls a home mortgage bubble. When corporations are forced to lay off workers in order to cut SG&A expenses, they incur the cost of extending their employee's employment benefits. Under the Bush administration, these benefits were temporarily extended beyond the usual 6 months. Almost as important as the percentage unemployed is the type of consumer that is out of work. When the dotcom and telecom bubbles burst, may well-paid professionals found themselves without a job. This was also the case in the early 1990's when companies made structural changes that eliminated many middle-management employees. Low unemployment rates lead to a growth in the cost of labor and in many cases creates inflation.