Some years ago, I visited a large Asian city to tour a number of manufacturing facilities and meet with government officials involved with trade and finance. My first full day there was a Sunday; business meetings were to commence the next morning. Having pretty much shaken off the jet lag, I decided to walk around the city by myself that afternoon just to savor a little bit of the city's culture, which was entirely unfamiliar to me. But I forgot that I would be the foreigner, not the thousands of pedestrians rushing past me on the street!

An hour into my sojourn I realized that I had no idea how far I had wandered from my hotel! I'd been so absorbed with the street vendors, the local dress and stunning architecture that I had neglected to make mental notes of landmarks or turns I had made. Instinctively I looked up for a corner street sign, only to realize that the street names were written in characters I could neither pronounce nor understand. Dusk was falling and the pedestrian traffic was quickly thinning; shaking off a sense of fear, I approached a friendly looking person to ask my whereabouts, but he shrugged and extended both palms skyward in an international gesture indicating that he either had no idea what I was saying or did not care to get involved.

Other strangers I approached were no more helpful. I did remember that I had a business card given to me by the concierge at the hotel. Eventually, one passer-by took pity on me, read the name of the hotel from this card and pointed me toward my temporary home. The experience made me permanently sensitive to the needs of immigrants and foreign visitors I encounter here in the States. It is very unsettling when you are lost and do not know the local language.

The Language Of Economics

You and I spend a fair amount of our time absorbing current data about business and the economy and digesting other professionals' opinions about the meaning of all this information. In a very true sense, this economic information is a language; one we rely on to keep our bearings in the changing economic landscape. It is a language unfamiliar to most of our clients. And yet they are regularly exposed to economic jargon in the daily newspapers and on TV, so much so that they often think they understand it more than they actually do.

Have you ever sat across the conference table from a prospective client who intones soberly, "Well, you won't be buying bonds, will you? I mean interest rates are going to go up." This happens to me a lot. If I think I have established enough of a relationship with the prospective client that I can kid a little bit, I'll say, "Oh, let me write that down. I have been wondering which way interest rates are going to go." Then it dawns on them that if I am willing to admit that I don't know which way rates are going next, maybe they don't know either. Then we can settle into a discussion that is respectful of the challenges of coping with the always-unknown future.

Our firm provides comprehensive personal financial planning services. Yet no matter how much time and effort we put into identifying goals, helping to minimize taxes and sorting through sticky estate planning issues, inevitably the most visible part of our work is investment management. Our clients, most of whom are either retired or getting close to retirement, are more interested in how their investments are doing than in anything else we do for them. Most of them are also interested in the thought process underlying our investment advice. I have found that to satisfy their need to know, as well as to keep myself in shape for the always-difficult task of investment management, I need to listen carefully to the economy, try to understand what it is saying and translate it for my clients as well as for myself. If you are thinking, "Easier said than done," you are right.

Unlike English or French or Japanese, the language of economics is subject to short-term changes that alter the meaning of information you thought you understood. Recently, for example, employment data was released indicating that 6,000 new jobs were created in a particular month. A few weeks later, the data was "restated" to show that actually 60,000 net jobs were lost that month! It has become commonplace for the percentage change in GDP for a calendar quarter to be revised by 10% to 30% in subsequent iterations. So, those of us who are trying to understand the meaning of the information, trying to translate it into investment decisions and to interpret it for clients who do not speak the language, need to have a way of coping with the undependability of the data.

One way I cope is to try very hard not to be influenced by any one data series or by information coming to light over a short period of time; this requires great stoicism sometimes, especially when a surprising number is announced that suddenly impacts the securities markets. I try to hear economic information in the context of longer-term developments. This way the inevitable restatements are less disturbing, and I have more time to think through the relationships between different kinds of data.

A related coping technique is that I hold in my consciousness a small number of big-picture realities. When current information is released, I ask myself how it compares with those realities and whether it confirms a long-term pattern or suggests a change of direction. Some staples that I rely on: In the long run, profits can only grow as fast as nominal GDP; the average consumer will spend all he (she) can; producers will raise prices if they can; the Orient can provide goods and services cheaper than we can; stock prices reflect earnings expectations, which are part fact, part feelings; and in the short term anything is possible in securities markets.

Following is an example of the longer-term, big-picture realities within which I try to listen to what the economy is saying today; it is my historical perspective for evaluating and interpreting new information as it is released.

Historical Perspective

In the half century following World War II, the U.S. economy enjoyed steady growth, punctuated only by more or less benign business-cycle corrections. These were characterized by the Federal Reserve Bank initiating a tight-money environment that truncated consumer demand, causing inventories to build up, which, in turn, called for temporary reductions in the manufacturing workforce that further weakened consumer demand. Eventually, interest rates would fall, excess inventories would be worked off, manufacturers would tentatively begin hiring again, consumer optimism would rise, and a new cycle would be born. Each business cycle went to higher highs and each generation of workers enjoyed a better standard of living than its predecessor.

Americans became used to this virtuous cycle, both as consumers and as investors; we began to count on it, to expect that it would always be thus. So confident were we as consumers that we were not afraid to borrow against our future earnings and spend it to improve our current standard of living. As investors we pursued "growth" in our portfolios and our optimism allowed us to pay higher and higher prices (measured in P/E terms) for the expected future results; we cared less and less about current dividend payments, and counted more and more on future earnings growth that would give us stock price appreciation.

Four factors drove the 50-year growth that made the United States the envy of the free world:

a) Work force growth (rising population and increased participation of women in the work force),

b) Productivity gains, which trickled down to workers in the form of higher real wages,

c) Rising use of credit, which fueled demand, and

d) Strong growth of exports to the rest of the world.

Of these four growth factors, only productivity remains a probable stimulant for the near future. Credit use by consumers and corporations could actually go into reverse and become a drag on the economy (see our October column). I believe it is a very good bet that growth in the U.S. economy, indeed that of Europe and Japan as well, could be labored over the next decade. That is not the future we have come to expect.

Interpreting The Data

The great challenge, of course, is to translate the continuous stream of economic data into an investment strategy and to articulate it so that it makes sense to my clients. I need to have enough conviction about the meaning of developments so that I can make changes in our portfolios that I will not need to second-guess with the next release of figures from the labor department. Again, I look to long-term historic relationships between securities values and economic realities.

Many people are shocked to learn that in the late 1940s and early 1950s common stock dividends were offering a higher percentage rate than interest on corporate bonds! It was normal to see a 2.5% corporate bond and a 6% or 7% dividend yield on the same company's common stock. It was the market's way of saying that it was not confident that dividends could hold up. The Depression was still prominent in our institutional memory, and investors wanted the security that bonds provided more than the growth potential that might be had in stocks. Price/earnings ratios were typically under 10.

As the great postwar American consumer engine powered the economy through inventory cycles to higher and higher peaks, the expectation of growth became entrenched. Investor optimism peaked temporarily in the 1960s with prominent growth stocks, the "nifty-fifty," selling at 40 times earnings and the market average boasting a P/E of more than 20. Dividends had fallen to about 3.5% while corporate bonds went begging with interest yields of 5% to 6%; this even though inflation was still poking along at 1.5% a year.

The Dow Jones Industrial Average crossed above 1,000 for the first time in 1966; but it wasn't until 1983 that it convincingly broke above that level. For the intervening 16 years the U.S. market was in a trading range! I mention this to demonstrate that it can take years to unwind a case of excess optimism in the valuation of stocks.

Overvaluation can even overwhelm strong nominal economic growth. Consider, for example, that in the 16 years while the DJIA drifted sideways, our Gross Domestic Product multiplied fivefold, from less than $600 billion to more than $3 trillion. That was a great period of nominal economic growth, but it was not enough to produce rising stock prices for America's largest companies because the stocks began the period at a price based on too much optimism.

Today, more than half a century after World War II, even after a dismal two-and-a-half years of a bear market, stock prices still seem to reflect strong investor optimism based on the virtuous economic cycle to which several generations of American investors have become accustomed. If I am correct that three of the four factors that propelled our national growth the past several generations are actually neutralized, then the recent stock market weakness could be just a part of a longer-term realignment of expectations. If investor expectations adjust to slowing nominal GDP growth, ushering in a return to a historically more "normal" market P/E, we could have ahead of us an extended period of lackluster market performance such as we saw from the late 1960s to the early 1980s.

The Current Synthesis

Here we are today, saddled with a below-average recovery in GDP and tepid jobs growth despite a stimulative yield curve and strong spending by consumers and the Federal government. The prices of homes, college education and health care keep ramping up, yet the overall inflation number is tiny. Does this landscape seem unfamiliar? Do you feel a little lost? The apparent disparities make more sense when they are considered in the historical context (above).

Consumers still account for two-thirds of end demand (government and business for the rest.) They (we) can be counted on to do our part because consumer spending has not had a down year since The Great Depression! But more and more of our outlays are finding their way overseas, especially to the Orient ... witness the growing trade deficits with China and Japan. Hence, U.S. businesses find themselves with overcapacity. Put these together, and we can hear the economic data explaining low inflation (no pricing power for U.S. producers), slow nominal GDP growth, meager job opportunities and weak corporate profits. Our big task is to figure out the degree to which this is a new environment or a cyclical phenomenon.

As new data streams across my computer screen each week, I try not to put much reliance on the pundits' interpretation of every number; their job seems to be to sensationalize each announcement. Instead, I think of the data as words and phrases in a long, continuous monologue by the economy; it is willing to help me find my way, if only I will listen carefully.

J. Michael Martin, JD, CFP, is president of Financial Advantage in Columbia, Md.