For most, financial and economic forecasting is considered a relatively boring subject (that we find it fascinating and fun may explain why we are available most Saturday nights on short notice). OK, let’s edit “relatively boring” and just admit that most find it “extremely boring” and would rather attend a Kars4Kids concert than spend time performing or reading economic analyses and forecasts. It is generally a deep review and comparative analysis of current business cycles, myriad statistics, dry surveys, etc. and applied toward the future based on statistical analysis, historic comparisons, trends and experience. We will try to be more conversational here.
There are always changes, updates, and surprises which alter original estimates (yes, we’ve heard all the jokes comparing economists to weathermen). Politics and policy have always had a hand in this, but these days we find this to be such a huge – or yuge – factor, that it’s difficult to gauge. The Mideast remains on fire. In the last year or so we’ve seen China flex its muscles over international boundaries, Russia rise again, North Korea become even more belligerent and unpredictable, and “Brexit.” Arguably, the predictability and influence of these events pales with the election of a political novice and relative outsider to the presidency of the United States. While “experts” universally predicted that this would cause markets to crash here and abroad, once again they were appallingly wrong.
In 2007, author and NYU Distinguished Professor of Risk Engineering Nassim Taleb discussed the danger and seriousness of irregular, rare and random events that could have unpredictable (and usually negative) effects on society, as well as financial markets. The premise is an update of the theory he named his book after: “The Black Swan,” which has been described as one of the most influential books since WWII. We mention this because it is relevant to today’s environment.
As we said, predictions that a Trump presidency would lead to market collapses, economic ruin, famine and pestilence, have so far proved to be slightly exaggerated. Most global markets have rallied; in the US the Dow Jones Industrial Index has hit record levels and gained nearly 20% in the eight months since the election. While fundamentals and economic conditions do not support this, as we’ve written previously this exuberance has been accredited to the market’s “animal spirits” (see 2016 Q4 commentary “Deplora-Bull Market”). This is based on the belief that a Trump presidency will be able to de-regulate markets, lower taxes and unleash the US’ economic power, by sheer will alone. Wags have since coined this phenomenon an “Orange Swan” event.
However, the stock market does not in all cases directly reflect the economy. Today we are arguably near the tail end of not only one of the longest recoveries, but the weakest recovery economically in modern times. For the first time we have had eight consecutive years of sub-3% GDP growth; this is unheard of, especially after a major recession. Usually, the greater the recession the greater the recovery; unfortunately this is projected to continue for at least the near future. The Atlanta Fed just slashed its Q2 GDP estimate from a wishful 4.1% rate to a by-now-normal rate of 2.3% (for comparison, China grew by 6.9%). This more accurately reflects views from in the field.
In layman’s terms: We are not saying that the US economy is in a shambles or has no bright spots, but we could literally fill pages with additional, similar data to that above. It is rare that people see a correction (or recession) approaching, but we remember that in the summer of 2007 the bulls were snorting their loudest.
According to the government’s own statistics, labor participation remains near its lows; people are retiring later or returning to work for economic reasons; wages and hours worked remain stagnant. Corporate profits are not increasing at a pace to justify increases in share price and the markets themselves are trading at multiples last seen just before the last two major market corrections in 2002 and 2008. We believe it is prudent to remain on a somewhat defensive footing, and would rather give up some of the last gains in what is currently an inflated market in order to be protected on the downside; remember- overbought markets tend to oversell before reaching equilibrium.