State of the Economy: Q1
How do you see the overall state of the economy?
The presuppositions you bring to the discussion will dictate everything you believe about the economy. My late father used to say, “There are no brute facts.” We interpret everything through a given lens. (Incidentally, this was the study of his doctoral dissertation as well and the academic task he dedicated his life to – the study of presuppositions and their effects on one’s epistemology – on one’s overall worldview. He was a philosopher; I merely manage money – I have the easier part.) Raw data devoid of presuppositions cannot tell you what is happening in the economy. Why? Because existing home sales are up but new home sales are down. Manufacturing is up but export orders are down. New job creation is up but wage increases are down. Consumer spending is up but not even close to as “up” as many pundits predicted when oil prices collapsed. Brazil and Russia are in recessions but China and Japan are growing. Consumer confidence is up but business confidence is down. Do you get my point? There is not a clear mechanism or clear set of data by which one can authoritatively declare, “This is how the economy is doing.” I subscribe to the theory that bond yields are the best indicator we have but bond yields are permanently subject to distortion by the actions of central banks and by the muddy waters between economic growth/contraction and inflation/deflation. So, at the end of the day, most pundits become ideologues, not scientists. Economics is social science above all else. And my late dad was right, there are no brute facts. My presuppositions tell me that analyzing every bit of data I can get my hands on is useful, and avoiding dogmatic conclusions about the overall economy is mandatory to avoid inflicting harm on my clients. Humility is more important than data. And more important than all of the above – an investment approach that allows for different seasons of weather without inflicting permanent damage.
How are we looking with earnings season?
With 57% of companies reported we have seen 70% of companies beat their expectations. Year-over-year it appears each sector will experience earnings growth besides Energy and Utilities and possibly Industrials. Healthcare and Technology are earnings growth leaders. Only 49% of companies have exceeded expectations in top line revenues, so that delta between earnings surprises and revenues surprises is the story of margin expansion, a story that we have been told for years now is coming to an end. In aggregate, thus far earnings are 3.2% higher than they had been expected to be by consensus – a very decent showing.
Any clues on future Fed/monetary policy decisions?
The FOMC (Federal Open Market Committee) did meet Tuesday and Wednesday of last week. I continue to believe that more than improving jobs data and any particular GDP growth figure, the final item the Fed is inexplicably looking to see before beginning the process of rate normalization is inflation – some signs that we are seeing a resumption of inflation in the economy (2% inflation being their stated policy objective). The PCE indicator came out this week (Personal Consumption Expenditure index) as did the ECI indicator (Employment Cost Index). The ECI did show some pick-up in average hourly earnings, but you can see there is still room to go before the Fed will feel like there is real movement.
Additionally, last Wednesday’s GDP report (1) showed 0.2% GDP growth in Q1, below expectations of 1% real growth. It is worth noting that these GDP numbers are massively prone to I am simply unconvinced that the Fed is even close to considering a rate increase at this time.
Has 2015 been a year like no other thus far?
For us at The Bahnsen Group, YES! (But I know that is not what you are referring to.) As for the markets, I would say two things: 1) Japan’s five-year bond yield dropping below 0% has never happened, Deflation hitting the UK has really never happened, The Euro hit a 12-year low, the German DAX hit an all-time high, Oil hit a six-year low, the Nikkei hit a 15-year high, and U.S. unemployment dropped in all 50 states at once for the first time in over 30 years – so, it has been a unique year so far; 2) There is nothing unique at all about unique things happening. It is customary and expected for things to happen that have not previously happened. What would be unique is if four months ever went by without a plethora of uniqueness. Such is the nature of economic markets.
Do you see the rising China stock market as evidence of good things to come in the Chinese economy?
It has added to their overall GDP growth which has declined to +7% but that is with financial services growing 15%. The contribution financial services are making to GDP growth in China is increasing, and much of this is fed by increased stock market participation. The risk is that margin debt is increasing, and if too much money gets diverted from core business and economic activity to stock market speculation, a bubble is likely to form and the consequences will be worse than they otherwise would have been. Not being investors in the Chinese stock market, our clients are not directly impacted by any of this, but it is a noteworthy story for the potential contagion effects – effects that have both positive and negative possibilities.
Bullish argument #1 for the U.S. stock market:
The high level of investor skepticism and agnosticism. I am forced by the testimony of history to acknowledge that bull markets historically end with far higher levels of euphoria and optimism and complacency than we presently see.
Bearish argument #1 for the U.S. stock market:
Earnings growth is positive but slowing compared to prior years. Margin debts are high. Federal Reserve accommodation will, at some point, be less than it has been. (Okay, that was three arguments, but they are all important.)
Asset allocation conclusion around the above two questions and answers?
I am “even weight” but not over-weight and not yet under-weight in stock allocations. May see cash come to 3-4% over coming months as defensive/dry powder positioning.
What are your thoughts on the U.S. dollar?
I read a fascinating report recently that demonstrated with painfully clear support the extent to which the U.S. dollar has most rallied over the years when global growth has been most challenged. Inversely, U.S. dollar weakness has most often been a byproduct of strengthening global economic growth. I do not see the recent dollar rally (and subsequent leveling out) as a secular sea change, but rather a relative reflection of global growth comparisons – matters that are all intrinsically cyclical.
What do you make of the economic recovery we are presently in COMPARED to past recoveries?
A few tidbits courtesy of the spectacular Stanford economist, John Taylor: The Real GDP growth rate in the five years after the early 1980’s recession was 4.8%; the Real GDP growth rate in this economy has been 2.3% per year – less than half of the economic growth (and that is NET of inflation; the nominal gap is even larger). A full 5% of the population went from not working in early 1983 to working by 1988. 5% of the total bodies in the population. The unemployment rate has come down the last five years, but there are absolutely no more PEOPLE working now than there were six years ago. We have the same sized workforce that we did. Most significantly, the Keynesians would have us believe that the great evil of all economic slowdowns is people saving too much; however, the savings rate in the 1980’s was 9.1%; it currently is 4.4%. And which recovery has been stronger, despite that awful fact of the 1980’s savings rate being more than double what it is today? (If the written word fails to capture my sarcasm, please note that I categorically dismiss, out-of-hand, the notion that increased savings and investment is bad for an economy.)
We know MLPs have rallied a bit since their recent lows, but what is your underlying argument for their continued viability?
To borrow from my friends at Miller-Howard, valuations are low, commodity demand is accelerating not contracting, the growth outlook for hydrocarbon production (and consumption) is massive, and the need for greater transportation and storage infrastructure is huge. All of these basic fundamentals combined with the monetary benefits of extraordinary dividend growth and impressive high current dividend yield (best of both worlds), it is a story to believe in.
Quote of the Week
“If you rate [these Fed actions highly], it is like a man who jumps out of a 20-story building and after falling 18 stories says, ‘so far, so good.’”
— Jeffrey Gundlach