Posts tagged ‘economic cycles’
Coast is Clear Until 2019
The economic recovery since the Great Financial Crisis of 2008-09 has been widely interpreted as the slowest recovery since World War II. Bill McBride of Calculated Risk captures this phenomenon incredibly well in his historical job loss chart (see red line in chart below):
Source: Calculated Risk
History tells us that the economy traditionally suffers from an economic recession twice per decade, but we are closing in on seven years since the last recession with little evidence of impending economic doom.
So, are we due for another recession? Logic would dictate that since this recovery has been the slowest in a generation, the duration of this recovery should also be the longest. Strategist Ed Yardeni of Dr. Ed’s Blog uses data from historical economic cycles and CEI statistics (Coincident Economic Indicators) to make the same case. Based on his analysis, Yardeni does not see the next recession arriving until March 2019 (see chart below). If you take a look at the last five previous cycle peaks, recoveries generally last for an additional five and a half years (roughly 65 months). Since the last rebound to a cyclical peak occurred in October 2013, 65 months from then would imply the next downturn would begin in March 2019.
Source: Dr. Ed’s Blog
Typically, an economy loses steam and enters a recession after a phase of over-investment, tight labor conditions, and an extended period of tight central bank monetary policies. Over the last seven years, we have experienced quite the opposite. Corporations have been very slow to invest or hire new employees. For those employees hired, many of them are “under-employed” (i.e., working part-time), or in other words, these workers want more work hours. Our country’s slower-than-expected growth has created an output gap. Scott Grannis at Calafia Beach Pundit estimates this gap to approximate $2.8 trillion (see chart below). The CBO expects a smaller gap estimate of about $580 billion to narrow over the next few years. By Grannis’s calculations, there is a reservoir of 5 – 10 million jobs that could be tapped if the economy was operating more efficiently.
Source: Calafia Beach Pundit
Bolstering his argument, Grannis points out that the risk of a recession rises when there are significant capacity constraints and tight money. He sees the opposite happening – an enormous supply of unused capacity remains underutilized as he describes here:
“Today, money is abundant and resources are abundant. Even energy is abundant, because its price has fallen by over 50% in the past year or so. Corporate profits are near record highs, the supply of labor is virtually unconstrained, energy is suddenly cheap, and productive capacity is relatively abundant.”
While new uncertainties have been introduced (e.g., slowing China, potential government shutdown/sequestration, emerging market weakness), the reality remains there is always uncertainty. Even if you truly believe there is more uncertainty today relative to yesterday, the economy has some relatively strong shock absorbers to ride out the volatility.
There are plenty of potentially bad things to worry about, but if it’s a cyclical recession that you are worried about, then why don’t you grab a seat, order a coconut drink with an umbrella, and wait another three and a half years until you reach the circled date of March 2019 on your calendar.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) , but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Waiting for the Hundred Minute Flood
Investors have been scarred over the last decade and many retirees have seen massive setbacks to their retirement plans. We have witnessed the proverbial “100 year flood” twice in the 2000s in the shape of a bursting technology and credit bubble in 2000 and 2008, respectively. The instantaneous transmission of data around the globe, facilitated by 24/7 news cycles and non-stop internet access, has only accelerated investor panic attacks – the 100 year flood is now expected every 100 minutes.
If drowning in the 100 year flood of events surrounding Bear Stearns, Lehman Brothers, Washington Mutual, AIG, Fannie Mae, Freddie Mac, TARP bank bailouts, Bernie Madoff’s Ponzi scheme, and Eliot Spitzer’s prostitute appreciation activities were not enough in 2008, investors (and many bearish bloggers) have been left facing the challenge of reconciling an +80% move in the S&P 500 index and +100% move in the NASDAQ index with the following outcomes (through the bulk of 2009 and 2010):
- Flash crash, high frequency traders, and “dark pools”
- GM and Chrysler’s bankruptcies
- Dubai debt crisis
- Goldman Sachs – John Paulson hearings
- Tiger Woods cheating scandal
- Greece bailout
- BP oil spill
- Healthcare reform
- China real estate bubble concerns
- Congressional leadership changes
- European austerity riots
- North Korea – South Korea provocations
- Insider trading raids
- Ireland bailout
- Next: ?????
With all this dreadful news, how in the heck have the equity markets about doubled from the lows of last year? The “Zombie Bears,” as Barry Ritholtz at The Big Picture has affectionately coined, would have you believe this is merely a dead-cat bounce in a longer-term bear-market. Never mind the five consecutive quarters of GDP growth, the 10 consecutive months of private job creation, or the record 2010 projected profits, the Zombie Bears attribute this fleeting rebound to temporary stimulus, short-term inventory rebuild, and unsustainable printing press activity by Federal Reserve Chairman Ben Bernanke.
Perhaps the Zombie Bears will change their mind once the markets advance another 25-30%? Regardless of the market action, individual investors have taken the pessimism bait and continue to hide in their caves. This strategy makes sense for wealthy retirees with adequate resources, but for the vast majority of Americans, earning next to nothing on their nest egg in cash and overpriced Treasuries isn’t going to help much in achieving your retirement goals. Unless of course, you like working as a greeter at Wal-Mart in your 80s and eating mac & cheese for breakfast, lunch, and dinner.
This Time is Different
The Zombies would also have you believe this time is different, or in other words, historical economic cycles do not apply to the recent recession. I’ll stick with French novelist Alphonse Karr (1808-1890) who famously stated, “The more things change, the more things stay the same.”
As you can see from the data below, the recent recession lasted two months longer than the 16 month cycle average from 1854 – 2009. We have had 33 recessions and 33 recoveries, so I am going to go out on a limb and say this time will not be any different. Could we have a double dip recession? Sure, but odds are on our side for an average five year expansion, not the 18 month expansion experienced thus far.
The Grandma Sentiment Indicator
I love all these sentiment indicators, surveys, and various ratios that constantly get thrown around the blogosphere because it is never difficult to choose one matching a specific investment thesis. Strategists urge us to follow the actions of the “smart money” and do the opposite (like George Costanza) when looking at the “dumb money” indicators. The bears would also have you believe the world is coming to an end if you look at the current put/call data (see Smart Money Prepares for Sell Off). Instead, I choose to listen to my grandma, who has wisely reminded me that actions speak louder than words. Right now, those actions are screaming pure, unadulterated fear – a positive contrarian dynamic.
Over the last few years there has been more than $250 billion in equity outflows according to data from the Investment Company Institute (ICI). Bond funds on the other hand have taken in an unprecedented $376 billion in 2009 and about another $216 billion in 2010 through August.
As investment guru Sir John Templeton famously stated, “Bull markets are born on pessimism and they grow on skepticism, mature on optimism, and die on euphoria.” Judging by the asset outflows, I would say we haven’t quite reached the euphoria phase quite yet. I won’t complain though because the more fear out there, the more opportunity for me and my investors.
As I have consistently stated, I have no clue what equity markets are going to do over the next six to twelve months, nor does my bottom-up philosophy rely upon making market forecasts to succeed. Evaluating investor sentiment and timing economic cycles are difficult skills to master, but judging by the panicked actions and bond heavy asset inflows, investors are nervously awaiting another 100 year flood to occur in the next hundred minutes.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, WMT, and AIG derivative security, but at the time of publishing SCM had no direct position in Bear Stearns, Lehman Brothers, JPM, Washington Mutual, Fannie Mae, Freddie Mac, GS, BP, GM, Chrysler, and any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
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