Is This as Good as it Gets?

I had the great fortune of attending a conference/vacation in Portugal recently, and, since the trip was part work and part fun, we had to attend a number of mandatory business-related workshops.  One of those sessions was a presentation from Commonwealth’s Managing Principal and Chief Investment Officer, Brad McMillan.  It is always entertaining and enlightening to hear Brad talk, and this time was no different.

He started off his talk by reinforcing some of the very positive things that are happening in the domestic economy – the significant amount of new jobs that have been created, the fact that consumer confidence is at its highest levels since 1999, and that the Federal Government has put into place tax cuts, while, at the same time, increasing government spending and keeping interest rates low.

All of these things have worked to create some very solid economic numbers.  But, Brad’s concern is a very real one . . . “how much better can it get?”

And there are a number of statistical measurements that have him concerned.  Business investment, for one, is trending down, and that typically points to a problem down the road.  And, yes, companies are hiring, but we are actually running out of skilled workers!  The data shows that we are actually in a negative situation, where there is less than one available skilled worker for each job that is out there!

Further, while it is true that consumers are confident, wage growth is not responding with the same kind of enthusiasm.  People are working, but wages can’t seem to keep up with consumer spending.  This, then, means more borrowing and less saving.  In fact, savings rates are the lowest they’ve been since 2008 – a year no one wants to relive.

Government borrowing is also on the rise.  And this contributes to our expanding budget deficit that is expected to grow to $1.2 billion by the end of next year . . . and, the last time we topped $1 billion was during the horrific financial crisis of 2007-2009.

We’re also seeing interest rates and gasoline prices start to slowly increase, and this creates another set of problems.  Where is the money going to come from to service the debt, and how much more of our discretionary income will go to fill up our tanks?  If this trend continues, it is going to subtract some of that consumer spending that has been driving the economy.

And, while it’s true that corporate profit margins are the highest they have ever been, Corporate America is keeping more of those earnings than ever – sometimes to buy back stock in the open marketplace and sometimes just to boost their retained earnings numbers.

Still, the tax cuts and increased government spending may give us a year or two before “high risk” turns into “immediate risk” when we’re likely to see a significant reaction from the capital markets.  And there are a handful of very well-respected analysts who see eerie similarities between this market and 1987.

So, what do we need to look out for?  Let’s examine what a fundamental “Bear Market” looks like.  It will typically follow four economic phenomena:

First, the economy actually goes into a recession.  The technical indicator of a recession is two consecutive quarters of negative economic growth as measured by a country’s gross domestic product (GDP).

Next we need to look at oil prices.  80% of the time when we have had a significant increase in the price of oil, it has triggered a Bear Market.

The third indicator is rising interest rates.  If the Federal Reserve Bank allows interest rates to climb too high, too quickly, that can spook investors, leading to selloffs in the markets.

And, finally, keep an eye on valuations.  If they get too high (with Price/Earnings ratios exceeding 30), that can be a harbinger of a serious recession and potential Bear Market . . . . and, by some counts, this last data point may be here already.

Today, most of the economic indicators point to a healthy economy . . . but, we are really not seeing much in the way of improving economic data.  It is certainly “not over” yet . . . but it really may be about as good as it gets, and that means we have to be diligent about keeping our focus on what’s next.

So, Brad thinks we have another six months or so until we might just see some “cracks in the pavement.”  If that happens, we’ll be ready to make and recommend some changes.

Stay tuned . . . . .