Roger Cuddy

Economic indicators such as the unemployment rate comprise a large part of the business news. Understanding the main indicators and their relationship to the overall economy will aid in understanding both the current economic condition and the most likely future developments. It’s well worth the time investment to learn the main indicators and how they relate to the overall economy.

Let’s start with some general characteristics applicable to all indicators. Indicators can be classified according to their correlation to the economy and their time relationship to the economy.

• By Correlation, does the indicator move in step or opposite the direction of the overall economy
  • Positively correlated indicators are referred to as Procyclic
    • Example, growth of GDP
  • Negatively correlated indicators are called Countercyclic
    • Example, the Unemployment Rate
  • Indicators not correlated to the economy are Acyclic and are of limited use for predicting or confirming movement
• By Time relationship
  • Leading indicators change before the economy does
    • Example, the stock market is forward looking and more indicative of expectations about future economic conditions than present
  • Lagging indicators change later than the economic state
    • Example, unemployment tends to continue rising for some time after a recession ends and the economy is on the upswing.
  • Coincident indicators that move in step with the economy
    • Examples, GDP, Personal Income.

The Conference Board publishes indexes of indicators corresponding to each temporal relationship. These indexes are widely followed and studied and the same applies to the components comprising the indexes. I will confine this discussion to indicators that are part of the Conference Board indexes but you should be aware there are other less widely used or published indicators. Some are quite fanciful such as the hemline and super bowl indicators. At the time I write this the ‘Hot Waitress’ indicator is garnering much attention. This table presents the individual components of the leading, lagging and coincident indicator indexes.

The Conference Board publishes a guide to their indexes that makes good reading both from understanding the indexes and general economic knowledge at well. You can get a copy at http://www.conference-board.org/publications/describebook.cfm?id=852 .

In the second part of these posts we will start to look at the leading indicators in depth. I’ll be coming back to this post and updating links to the others so just keep this one marked and you will be able to follow the whole series as I get it done.

8/25, Changed the title to make clear this is only covering the indicators included by the Conference Board.

Given the planned rise in marginal tax rates it’s a sure bet that interest in tax-free investments will also be rising. Comparing of taxable vs. other taxable rates of return is quite simple and the same for comparing tax-free instruments against each other but how do we compare taxable vs. non-taxable products? The answer is by converting one side to it’s equivalent rate. In other words, if we want to know how a 4% tax-free municipal bond relates to taxable bonds then we must first convert the tax-free rate to it’s equivalent taxable rate. This short article will demonstrate the methods for converting either rate to it’s equivalent.

Conversion of tax-free rate to it’s equivalent taxable value.

The mathematics are quite simple and there is a nice general formula you may use.

Tax-equivalent yield = return rate / (1 – your tax rate)

As an example if your marginal tax rate is 25% and you are considering a 4% municipal bond then to earn the same return from a taxable bond would require:

Y_taxable = 4 %/ (1 –.25) = 4%/0.75 = 5.33%

So it would take a coupon of 5.33% on a taxable corporate bond to give you the same income. Notice the direct relationship between your tax rate and the taxable return needed to equal the tax-free rate. Using the same example but changing the person’s top marginal rate to 40% the equivalent rate now becomes:

Y_taxable = 4 %/ (1 –.40) = 4%/0.60 = 6.67%

Conversion of a taxable rate to equivalent tax-free value.

This is just as simple but our formula is now:

Tax free yield = return rate * ( 1 – your tax rate)

Using our previous example to double check. If you have top marginal rate of 40% then a 6.67% taxable bond would be equivalent to

Y_tax-free = 6.67% * ( 1 – 0.40) = 6.67% * 0.6 = 4%

Poor Man Investment Club uses the Unit Valuation System (UVS) to determine and track each member’s contributions and current share of worth. The Unit Valuation System has been used by Mutual Funds and investment partnerships for a very long time and only appears complicated at first pass. I will attempt here to provide a simple explanation of how it works and a few simplistic but explanatory examples.

The basic formula for calculating ‘Unit Value’ is:

UV =  (Market value + Cash + Income – Liabilities – Expenses) / # units

Examining the case of a newly formed partnership with 2 partners who each contribute $100 to starting capital. The partners can either attach any value they wish to a unit at this time and then ‘buy’ the units desired or probably more commonly done they pick a number of units to start with that simplifies the first set of math. In this case they agree that the partnership will start with 100 units of which they will have 50 each.

Now the partners wish to put their capital to work in investments. They decide to buy 10 shares of sprocket’s ‘r’ us (ticker SPACELY) at $10 each as their first investment. In purchasing the shares they incur a $5 commission charge. Let’s examine how the unit value changes. We can handle the commission in two ways for this example. We can net it against the remaining cash after the stock purchase or we can just put it in the expenses column until the end of month/quarter/etc and net everything then. Let’s use the second method for now as it demonstrates the concept well.

So our sum of all unit values declined by the commission expense and when attributed out to each unit it was a nickel per unit.  Continuing with this example, let’s assume that the market value of sprocket’s r us rises to $12 per share and our partners are so pleased with themselves that they wish to add another $50 each to the partnership. How do we accommodate the addition of new money? First we find the new unit value at the time of adding the new funds.

So the new unit value is $2.15. Each partner wishes to add $50 which will purchase 50/2.15 = 23.2558 . So now each partner has 73.2558 units at a value of $2.15 per unit. Easy enough. Note that the beautiful feature of this is that allows any partner to purchase any amount of new shares at anytime just by calculating the current unit value and ‘selling’ the units at that cost to the partner adding funds.  Let’s look at our values after the purchase in example here and pay particular attention that the unit value doesn’t change. We just create more units for the influx of new cash.

For the last example let’s assume that the shares of sprockets ‘r’ us keep going up and reach $15 share. At $13 a share the partners bought 10 more shares with another $5 commission. The original 10 shares issued a $1 dividend (income). The new table would be:

I hope this short write up has helped everyone understand. If you still have questions you can leave a note here or just catch me at the next meeting.

Poor Man Investment Club uses the Unit Valuation System (UVS) to determine and track each member’s contributions and current share of worth. The Unit Valuation System has been used by Mutual Funds and investment partnerships for a very long time and only appears complicated at first pass. I will attempt here to provide a simple explanation of how it works and a few simplistic but explanatory examples.

The basic formula for calculating ‘Unit Value’ is:

UV =  (Market value + Cash + Income – Liabilities – Expenses) / # units

Read the rest of this entry »