This is very interesting. So if stock prices are a leading indicator, then all you have to do is look at the stock market valuations to know where the economy is going. GM’s rise from $20 to $30 in the last few months is a leading indicator that GM’s future is brighter than people thought back in April? This assumes the market has all information, and is efficient.

I just wonder how leading of an indicator the stock market was in 1999. The stock market was saying that company profits would grow to the stratosphere. Yet, the market was wrong, and thus, the prices finally crashed. Many mutual fund managers, including top-rated Janus Funds, lost lots of money.

For this reason, I’m not sold on the idea that the market is rational and has perfect information and pricing power. Toll Bros reached a high of $58 in 7/20/05, at the top of the housing bubble. I wasn’t paying attention to the company at that time, but perhaps others were; what made the stock starts its downward slide? Did investors realize the housing market would go down, or was the stock punished as a result of a lowered earnings announcement?