After being fooled by dot-com mania at the turn of the century, many stock investors vowed that they would not make the same mistake twice. So they turned to “can’t-lose” real estate. Of course, the housing bubble made fools out of many of the very same fortune-seekers.
Today, circumstances are more precarious. It is not stocks or real estate. It is stocks AND real estate. In fact, it is stocks, bonds and real estate – the assets that constitute record household net worth.
The “Everything Balloon” is not a figment of doomsayer prognostication. A little common sense tells people that household wealth cannot grow faster than an economy ad infinitum.
Sure. With enough debt – with enough leverage — household wealth can outpace U.S. gross domestic product (GDP) for a period of time. And I have to acknowledge that this period has gone on far longer than I ever could have imagined.
Yet the ultra-low interest rate accommodation alongside years of quantitative easing (a.k.a. balance sheet expansion) has left the world incapable of functioning without extraordinary stimulus. Indeed, the Federal Reserve abandoned plans to raise overnight lending rates as well reduce its commitment to reducing its balance sheet solely because the financial markets were free-falling in the 4th quarter of 2018.
Does the recent risk asset rally alter the effervescent particulars? Hardly. If anything, it may be fooling more folks into believing that future financial market bailouts will work precisely when the S&P 500 plummets -19.9%. (Long live the “Fed Put.”)
Ultimately, however, household net worth is going to revert back to the mean growth of the overall economy. A corrective phase for the S&P 500 alongside pockets of price drops in Seattle real estate won’t do the trick.
The entirety of the major assets — stocks, bonds and real estate — will find their way lower in revisiting the economic growth (GDP) trendline. The only question is… “When?”
Perhaps it would need to coincide with recessionary pressure. That likelihood may be a reason why many currently breathe sighs of relief. No recession in sight, they say.
However, it might be instructive to look at actual data. Unemployment. Consumer Confidence. Yield Curve. All of the things that have historically presaged economic hardship.
Unemployment. The way that I have interpreted the data, every recession began when the unemployment rate popped 0.4% off of its cycle low. In the current cycle, we have seen 3.7%. Now it is back to June’s rate of 4.0%.
In other words, investors might want to be cognizant of yet another increase in the rate to 4.1%.
Joseph LaVorgna, chief economist for the Americas at Natixis, actually puts it another way. His data shows a perfect 70-year record, since 1948, when the unemployment rate increases 0.5% from a trailing cyclical low (3.7%).
So is it 4.1%? 4.2%?
There may be some debate in the economic community. Yet there’s little debate where certain moving averages are concerned. And the 12-month moving average has rarely missed. (See the red circles below.)
Consumer Confidence. I actually used consumer confidence as part of my recession model to identify the 2008 downturn. My model evaluates whether or not future expectations are falling faster than how people feel at the present. If it is falling at a faster month-over-month clip than the present situation measure, an economy may be succumbing to contractionary forces.
A slightly different take is the discrepancy between how consumers feel about the present and their expectations for the future. Crescat Capital has pointed out that the gap between the two was only wider back in 2000. They note that, in the past 50 years, every other such drop resulted in a recessionary outcome. (Not to mention… ugly stock declines.)
Yield Curve. From where I sit, this one is ugly on multiple levels. We already have a fair amount of inversion at the short end of the curve. At last check, the 1s and 5s are inverted by 7 basis points; the ones and twos by 3 basis points.
Investors are willingly accepting less yield for holding longer-dated maturities. This screams “high probability” that the Fed is likely to lower its overnight lending rate in the near future in an effort to ward off a recession.
Bear in mind, when long-dated bond yields are lower than short-dated ones, the infrequent occurrence has almost always signaled recessionary pressure coming down the pike. And Crescat Capital offered up more evidence in the global bond arena. They found 12-plus significant economies with 30-year yields trading below the Fed Funds rate range (2.25%-2.5%).
It should be noted that Powell and a host of Fed committee members, past and present, have all downgraded their own description of the economy’s well-being. It is the reason that these leaders individually and collectively offered while flip-flopping from tightening to neutrality at the onset of 2019.
Skeptics and straight-shooters alike scoff at the idea that the Chairman Powell and his colleagues discovered data to change their minds. There is an understanding that the reason for the about-face had more to do with the financial markets falling into a Q4 abyss.
Nevertheless, central bank leaders do see the yield curve inversion. They are aware of historical precedent on unemployment rate changes. And they’re not blind to the fact that, in a consumer driven economy, consumers that see a bleak future are unlike to spend money.
In truth, the Fed sees even more. Monetary policy leaders see weakness in China as well as recessions/potential recessions throughout the euro-zone. Not to mention the unsustainable debt levels. Ironically, those debt levels were made possible by central bank policies (e.g., zero percent rate, negative interest rates, QE, etc.), but the decision to try to roll back those policies proved exceedingly painful in Q4 2018.
Another area is concerning Fed participants. Housing. Pending home sales are falling precipitously.
It’s not that you have to abandon your allocation to risk altogether. It’s not that you have to be tactical in the way that I lower client exposure to risk assets when fundamental and technical indicators instruct me to do so.
On the other hand, the premier times to take on risk typically occur after the Fed is frantically slashing rates and the economy is hurting in a very obvious way. That’s what occurred in 2001. That’s what occurred in 2008. And the best opportunities came as a result of those recessions — in 2002 and 2009 respectively.
So what is your plan to take advantage of genuine opportunity? Or will you be fooled for a third time by loading up on cannabis, crypto and cloud in 2019, price and valuation be damned?
Disclosure Statement: ETF Expert is a web log (“blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationship.