(MONEY Magazine) – If I had to make all of my investment decisions based on one single indicator, I'd pick the yield curve--the relationship among interest rates on debt of varying maturities. In particular, the difference between the yield on short-term investments and that on long-term alternatives such as Treasury bonds isn't merely a sign of where stock prices are likely to head. It actually causes the economy to speed up or slow down, and thereby determines the direction of share prices. Between July 2000 and early January, the yield curve was inverted--short-term interest rates were higher than long-term rates--and that basically triggered the slump we're still feeling. But since early this year, the yield curve has been getting more and more bullish. That's good news for the stock market as a whole. And it's especially positive for financial stocks, such as J.P. Morgan Chase and Fannie Mae.

The yield curve sounds complicated, but the basic idea is really quite simple. Long-term interest rates are determined in the marketplace, reflecting a host of economic factors, such as investors' views on the outlook for growth and for inflation. Short-term rates, by contrast, are set by the Federal Reserve. By manipulating the differences between the two rates, the Fed can direct the pace of the economy.

The way the yield curve works is just common sense. When short-term rates are high, savers can earn generous returns on safe, liquid investments such as money-market funds, so they have no need to take greater risks. But when short-term rates fall, many people start to move their savings into higher-paying investments like long-term bonds. As they switch money from savings to bonds, they typically also move money into stocks that appear to offer high returns. That shift from savings to long-term investments actually helps finance the economy's growth. Here's the bottom line: High short-term rates suck money out of the economy. Low short-term rates put it to work, bidding up stock prices in the process.

As you can see in the chart to the left, short-term rates exceeded long-term rates throughout the second half of last year. Then, as the Federal Reserve began to cut short-term rates aggressively in January, the relationship returned to normal. When long-term rates are at least half a percentage point above short-term, the yield curve is bullish. And by mid-June, that spread was approaching two full points--very bullish.

If the yield curve is in such a positive position, why has the stock market been so dismal lately? Two reasons. First, there's a natural time lag. Money may start migrating out of savings as soon as short-term rates fall, but it takes a while before enough money moves to make a real difference.

Today there's another factor hindering the stimulative effect of low short-term rates. The stock market boom from 1995 through early 2000 was so extreme that it left the economy with a hangover. Investors who lost money in the tech wreck are hesitant to start buying growth stocks again. Some specific sectors were devastated. The telecom industry is still suffering the effects of dramatic overexpansion. And financial companies lent too easily during the boom and now find they are saddled with a lot of bad debt.

Once the yield curve turns strongly positive, however, it's only a matter of time before the economy and the stock market follow. The industries that suffered from the worst excesses during the boom may be slower to respond. But ultimately, they will bounce back too.

That outlook creates excellent buying opportunities, especially among financial stocks. Not only are banks and other lenders direct beneficiaries of cheaper money, but they're also currently trading at fairly low price/earnings ratios relative to their expected earnings growth rates. Here's a look at two that offer double-digit annual earnings growth at P/Es below 15.

The stock market slump has hammered J.P. Morgan Chase in several ways. Like most giant commercial banks, J.P. Morgan was an aggressive lender during the boom and is now coping with lots of problem loans--particularly to tech companies, such as telecoms. It also made significant venture-capital investments in many of those same firms.

In addition, in the past five years large global banks have become increasingly dependent on investment banking activity, such as IPO underwriting and proprietary trading, both of which have been devastated over the past year.

J.P. Morgan won't realize its long-term potential until the stock market recovers. In addition, the bank will have to shrink its portfolio of problem loans and write down its bad equity investments. That's a process that can take a couple of years. But however long it takes to clean everything up, the bank will eventually be a powerhouse. J.P. Morgan offers projected compound earnings growth of 12% a year as well as a 3% yield. And yet at $44.50 the shares trade at less than 12 times projected earnings for next year.

Fannie Mae is an alternative way to play the positive yield curve. As the nation's largest provider of funds for home loans--buying, selling and guaranteeing mortgages--Fannie Mae took a direct hit from the Federal Reserve's tight-money policy in late 1999 and 2000. And currently, loan losses are up a little because of the economic slump. While relatively minor, they've still taken a toll on the stock price: Fannie Mae shares have been flat throughout the first half of the year, despite the increasingly positive interest-rate environment.

That stagnation probably won't persist much longer, however. The mortgage and refinancing markets are strong, and earnings rose nearly 18% in the first quarter. Going forward, Fannie Mae's earnings prospects seem to me at least as good as they have been over the past five years, when the company achieved an impressive compound growth rate of about 13.5% annually.

Given that core growth rate, enhanced by a 1.4% yield, Fannie Mae should reward investors with a well-above-average return. At its current price of $82.30 a share, the stock trades at less than 15 times next year's estimated results. Few stocks offering that kind of growth are so cheap, even in this depressed market. And once a broad recovery starts--probably before year-end--Fannie Mae isn't likely to remain so cheap either.

Michael Sivy can be reached at sivy_on_stocks@moneymail.com.