As you know, GDP is reported by the government after market activity has occurred. The stock market is priced daily on the whims of current news and events. For this reason, the DJIA will always trade around GDP, at some multiple above or below it.
Remember that GDP is where the DJIA always wants to go. That’s its goal. Knowing this, it’s easy to draw a parallel between the two and use them to define a range to make your investment transactions. I call this range an action zone.
For instance, the Dow traded at an average GDP multiple of .89 for the past 15 years (1995-6/2011). The low multiple was .61, and since the last bottom (2002) it was .83. Once these multiples are applied the results suggest that the DJIA will trade between 9,184 and 13,323 until the next correction. That’s the action zone.
You can always profit by targeting the midpoint of the action of zone to make your investment moves (right now 11,245). That’s about 700 points higher than what I wrote in chapter 8 of LOSE YOUR BROKER NOT YOUR MONEY. Why the change? Was my book wrong?
No. Market conditions changed.
The Fed has pumped more than two trillion dollars of currency into the economy and has continued to run trillion dollar deficits since I wrote that chapter. Both practices are extremely inflationary, and right now both the economy and stock market are artificially inflated. Sooner or later they will have to correct.
How do we know?
Because the government can’t keep running trillion dollar deficits while printing currency like it grows on trees. Once these practices stop, the economy will return to recession and the stock market will sell off. That’s the way it works.
My advice: Don’t try to sell at the highest and buy at the lowest. It’s Buy Low Sell High. Pick a spot in the action zone to make your move and then wait for conditions to change — or better yet, a clearance sale to Buy Low.
(PS: Remember the stock market overreacts to everything. “The market” can easily trade below 9,184 when correction hits. In fact, you can count on it.)