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Finding the Missing Link Between Stocks and GDP

Famous advice is timeless. Such suggestions as "Go west, young man," and "plastics" may not retain their original import, but would you counsel a modern-day successor to The Graduate with "nanotubes?" Peter Lynch's fame as the longtime manager of the Fidelity Magellan Fund was such that even though he retired from this role more than 13 years ago, he arguably remains the world's most famous mutual fund manager. Part of his fame is no doubt derived from his pithy aphorisms, such as "know what you own," and his trenchant observation that if you spend more than 15 minutes a year thinking about the economy, you've wasted your time.

I must, as an economist, reject this last observation, but in homage to Lynch's career, I'll offer the following candidate for advice immortality: "Retire early."

In Search of the Lost Chord

I concluded last week's declamation of the stock market-GDP link with a chart of the residuals, or unexplained portion, of a model of inflation-adjusted total return on the S&P 500 based on inflation-adjusted GDP. These residuals were not the desired random, or white-noise, process distributed trendlessly around zero, but rather a descriptive process in their own right. If we can model the series charted below successfully, we can learn which macroeconomic factors to follow for future stock market direction.

Something Is Missing
Source: Howard Simons

Step One is always trust your eyesight. The most powerful computer around is still the one between your ears and it's hard-wired to recognize visual patterns. Think about our tree-swinging ancestors who needed to guess where the next branch was. This is why the first step in investment analysis always should be a glance at the chart. As an added bonus, we can conclude from the above that successful chartists and most orangutans are really kindred spirits; that is today's contribution to the great and never-ending technical vs. fundamental debate.

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