Surprised by Normality
Volatility (VIX) seems to be a major topic in the marketplace. While this might be unnerving, the current volatility is in line with the twenty-year average and the present market data indicates the fundamentals of the market remain strong. We are providing you with the following charts and our thinking to help you understand our market position and put your mind at ease.
What is Evident Long-Term
According to present data, the US consumer (representing 70% of our economy) remains strong on most measures. Some of these measures range from consumer confidence to hard data such as credit card delinquencies and unemployment. According to the Bloomberg chart below, credit card delinquencies have significantly decreased over the last ten years-suggesting that the US consumer has both the ability and willingness to spend without accumulating long-term debt. Further, because the consumer drives sales, sales drive profits, profits drive earnings, and earnings drive the stock market, the consumer can greatly affect both the health and trajectory of the market.
Along with the US consumer, US Corporations and domestic firms’ earnings continue to remain strong. Because corporations are experiencing an increase in earnings, US businesses have been able to expand through capital expenses and hiring additional employees. Further, after reviewing both qualitative and quantitative data, including earnings growth, manufacturing surveys, and corporate capital spending, it is clear that these areas have crossed milestones dating back six years to decades.
Each area mentioned above, along with dozens of other market indicators, are what we, as a firm, measure on a daily, monthly, quarterly, and annual basis. This same effort and depth of review is also used when our firm evaluates benchmarks for bonds, economic, and international data.
What is also Teased out from that Data
“Every [bull market] carries the seed of its own destruction”
- Mark Twain’s Eruption, altered
While the paraphrase above is a blatant exaggeration, it is often true that every bull market has the seeds of its own end buried within its data. If we were viewing the market through rose-colored glasses, it would be easy to call it a day and go home after seeing the positive data listed above. However, our job is to sort through the tea leaves for signs of the next stage in the various markets. Then, we can incrementally adjust our clients’ portfolios relative to any potential risks we may see in the market. Explained below are a few potential areas for risks or weakening in the current market condition. *
1. Real wages are decreasing. Despite the fact that the market experienced a recent jump in wages a month ago, once these wages are adjusted to reflect the current cost of living, it is evident that wages have dropped since the great recession (see chart below). This data implies that full inflation, including housing and energy (things we actually use), are rising faster than real wages have increased. In other words, wages have not been able to increase rapidly enough to keep up with the current cost of living.
2. Consumer rate of savings is decreasing. The consumer’ rate of savings (first chart on the left, below) is back to the lows reached during the great recession in 2008. While this reinforces the consumer’s confidence, this also implies less capacity for continued growth.
3. US Consumer is hitting the upper end of their ability to spend. Although we have experienced a consistent increase in consumer spending over the years (middle chart below), it is only a matter of time that the consumer will reach their capacity for a higher pace of growth if the economy continues to grow at its current rate.
4. Housing may not be as significant of a factor to economic growth. Current data implies that continued economic growth will come from either housing or government spending. However, housing, as the last chart on the right shows in green, has already taken the brunt of the inflationary pressures during this last growth phase, and should not be relied upon long-term. On the other hand, government spending (in the form of infrastructure spending), similar to last year’s tax cuts, could become a significant factor in economic growth.
After reviewing current data, it is evident that investors are in great shape, and the economic backdrop remains healthy. Despite the positive analysis, our firm continues to look for pending areas of risk to see if these areas will prove to have a positive or negative impact on the economy. By performing an ongoing and thorough analysis, we can then implement incremental moves across our clients’ stock and bond portfolios-positioning them for any present or potential volatility in the market.
* This is a narrative not only of the CFA LA’s Annual Forecast dinner, courtesy of BMO, but also espoused by others using similar data.