When our portfolios are headed higher, we usually go out and spend like the dickens.  After all, with nice fat investments we feel like we have a lot more money to spend.  And, as well all know, spending drives the economy.  Result:  Stock prices and the economy get a boost.

In addition, the wealth effect is a brand of self-fulfilling prophecy, which makes it even more powerful…

By investing in stocks that go up, we have more wealth.  Having more wealth causes us to go out and spend.  That spending, in turn, causes the economy to grow.  Economic growth then leads to better times for companies which, in turn, lead to higher stock prices.

Unfortunately, the power of the wealth effect works in reverse as well…

When we see our stock portfolios getting hammered, we feel a lot less wealthy.  That loss of wealth causes us to pull back on spending.  Less spending means slower economic growth, which is lousy for companies.  Poor outlooks for companies mean lower stock prices.

And declining wealth isn’t limited to stocks.  Take a look at this chart of real estate prices…

As you can see from this graph, the year-over-year change in home values — indicated by the dark solid line — began to slow around the beginning of 2006.  But economic growth — indicated by the red dashed line — didn’t begin to slow until the middle of 2008.

In other words, the wealth effect in real estate wore off long before the economy began to sputter.  In this case, the declining value in real estate was a huge leading indicator of poor economic activity to come.

In fact, changes in just about any asset — from stocks to houses to commodities — can cause their owners to adjust their spending habits.  And those spending adjustments are going to happen after the owners’ assets take a hit.  And that makes them a great predictor of where things are headed.

I’ve told my readers time and time again that a recovery in real estate prices — and stability in the real estate market — is likely going to be one of the biggest pluses for a stabilized economy and higher stock market values.  Real estate got us into this mess and it’s going to get us out.

Using These Leading Indicators for Profit

So, how can you make money off the predictive abilities of the stock market and other asset classes?

Simple.  While others are waiting for the big economic indicators — such as solid growth, the labor market, and the credit crisis — to get back on their feet, you can slip into key investments long before anybody else gets wind. The markets are telling us loud and clear patience will be rewarded.

Best wishes,
Wayne Burritt

January 7, 2009

Profiting from the Wealth Effect was originally featured in the Penny Sleuth.

Of these 75 names, 14 are Americans born within nine years of each other in the mid-1800s. Magnates like John D. Rockefeller, Andrew Carnegie and J.P. Morgan, to name a few. Best-selling sociology writer Malcolm Gladwell says that’s no coincidence. Gladwell’s latest book, Outliers, explores how factors other than intelligence and ambition affect the most successful members of our society.

In this case, the decade in which these powerful people were born was just as important as their vision and drive, according to Gladwell. “What’s going on here?” he writes:

“The answer becomes obvious if you think about it. In the 1860s and 1870s, the American economy went through perhaps the greatest transformation in its history. This is when the railroads were being built and when Wall Street emerged. It was when industrial manufacturing started in earnest. It was when all the rules by which the traditional economy had functioned were broken and remade. What this list says is that it really matters how old you were when that transformation happened.”

The Right Place, the Right Time…

Just as railroads, steel and manufacturing shook up 19th-century America, the credit crisis and this wicked bear market are changing our own investment universe.

We have to take advantage of the fact that we are in what could be the right place at the right time. The market is presenting us with tremendous opportunity. And what better place to look than at the smallest public companies in the world — the aggressive, nimble firms that can adapt and grow while the titans of the old world slip and fall.

While the GM and Ford’s of the world struggle to shed the weight of their past, small companies have a much easier time of adjusting on the fly and adapting to the new economic conditions. Some of the biggest names on Wall Street fell this year because they were slow to react when the credit crisis was on the horizon.

In our current issue of Penny Stock Fortunes, we’ve giving our readers four small companies that are well positioned to make the transition to the post-credit crisis reality. You won’t read about these companies in the Wall Street Journal, but that just means you have a better chance to load up before the rest of the market catches on. You can join our readers at Penny Stock Fortunes, and learn about our CXS Money-Multiplier System, in this special report.

Best Regards,
Greg Guenthner
December 4, 2008

Penny Stocks and the Post-Credit Crisis Reality was originally featured in the Penny Sleuth.