"It's The Economy, Stupid"

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When James Carville hung a sign with the phrase, "It's The Economy, Stupid" on Bill Clinton's Little Rock campaign headquarters in 1992 the message to campaign insiders was pretty clear - Clinton was a better choice than Bush because Clinton understood what the economy needed.

Now, I'm not going to get all 'political' on you today - but I am going to talk about the economy. Whether or not Clinton really delivered what the economy needed in the early 1990s is debatable. But what's not debatable is that the market and the economy are intertwined - so investors need to be aware of what's going on in the economy right now and consider how it will affect stocks moving forward.

***Earlier this week the Conference Board released the results of the latest Consumer Confidence Index. The results were dismal as the September consumer confidence level dropped to 48.5, down from 53.2 in August. The index measures consumers' feelings on the job market and general business conditions over the next six months.

"Overall, consumers' confidence in the state of the economy remains quite grim. And, with so few expecting conditions to improve in the near term, the pace of economic growth is not likely to pick up in the coming months" said Lynn Franco, director at the Conference Board Consumer Research Center.

Experts think consumer spending will increase only at a modest pace throughout the rest of the year. This will hold back GDP and limit growth in all sectors of the economy.

"The economy is stuck in an unvirtuous cycle. Consumers are waiting for more jobs to be created, and businesses are waiting for consumers" believes Wells Fargo economist Mark Vitner.

What's needed is a positive feedback loop in which greater consumer confidence leads to consumer spending. In other words, the consumer needs to be a part of the recovery - and that comes down to job creation. Keep an eye on job creation and consumer confidence numbers and look for stabilization in the trends to signal a good time to buy stocks. When they improve, the market will likely have already moved higher.

***Right now President Obama's staff could hang a sign on the oval office that says, "It's Housing, Stupid". Any politician that doesn't see the direct correlation between a stable housing market and economic recovery should get a place in the unemployment line.

According to the S&P/Case-Shiller Index, housing prices increased 3.2 percent from July 2009 to July 2010. New home sales, existing home sales, and new housing starts all beat estimates last month as well.

The Fed has done everything in its arsenal to drive short-term rates as low as possible - thus bringing down mortgage rates and making homes more affordable. It still has the option of purchasing long-term securities in the open market which could keep rates artificially low for an extended period of time.

But is this helping? "What's hurting the housing market right now isn't mortgage rates. It's a lack of confidence about the U.S. economy. It's concern about losing a job" exclaims Michelle Girard, economist at the Royal Bank of Scotland. While affordable housing sounds great, people will only purchase housing if they have reliable income. So housing comes back to job creation as well.

The housing market is bouncing around near what could be a bottom in my opinion. Even though prices have declined significantly over the past 3 years, it's unlikely they'll drop significantly from here - unless we enter into a new recession. I think that's unlikely, and now is a good time to add exposure to the housing market for investors with a longer time horizon.

In fact, I just added a stock to the Small Cap Investor PRO portfolio that has fallen because of exposure to housing. But moving forward this company is increasing exposure to faster growing sectors of the economy. When investors realize housing is only part of the revenue stream, the stock could soar. Click here to learn more.

***A pickup in manufacturing is also critical for a recovery. Last month the Institute for Supply Management's factory index fell from 56.3, to 54.5.

" The manufacturing sector is still reasonably healthy, but it's certainly decelerated. We need to see a pickup in hiring to drive faster income growth and lead to acceleration in consumer spending [or] we're doomed to this sub-par growth" stated Stephen Stanley, economist at Pierpont Securities.

Again, manufacturing is all about jobs. Without taking on more debt, pretty much a no-no right now, consumers won't spend when they don't have a job. And manufacturing won't pick up without growing consumer demand.

So really, "It's all about Job Creation, Stupid" is the sign that should be hung on the door to the Oval Office, the Fed, and every street corner, municipal, and state office complex throughout the country.

Consumer confidence, housing, manufacturing - all come down to job creation.

We're seeing moderate improvement across the board even thought data is bouncing around a little bit as we move toward the end of 2010. Look past the noise and you'll see that the data are showing an economy recovering at a modest pace. Investors are taking note.

Take a look at the chart below, which shows the return of the S&P 600 small cap index over the last year.

Since July 1st, t he S&P 600 has returned 10.6 percent, and appears to breaking out above resistance. I don't fully trust the move and wouldn't be surprised to see a pullback. But I don't think we'll retreat back to 320.

Investors are catching on that the economy is stabilizing, and stocks are finding long needed support. Expect things to get more volatile in coming weeks as earnings season begins and speculation picks up as to which sectors are actually poised to grow, and which will stagnate.

What do you expect from the upcoming earnings season? Let me know. My address is: editorial@smallcapinvestor.com .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Stocks

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