This brief update is intended to provide you with some insight regarding the current state of the markets relative to some interesting historical data. Although some of this data may be alarming – keep in mind that we work hard not to be surprised by the volatility that can come from extended (highly or richly priced markets), or on the other hand relatively inexpensive markets based on conventional wisdom. Understanding where the market is and could be headed is key to benefiting from it through seasons like this. Our goal in writing this is to help you understand what our research is showing us and trust that this briefing will help you understand some of our strategies as we work to benefit from what we are seeing.
As you may know, roughly 70% of US GDP is attributed to the consumer. That means as long as the consumer is in good shape and they’re able to continue spending, the economy can chug along without severe bumps in the road. To assess the longevity of an expansion or contraction in the economy, you don’t need to look much further than the health of the US consumer because it is such a powerful and well-trained force. If people have money in their pockets, they tend to go ahead and spend it. This is why jobs numbers and US employment reports are key data points to watch when it comes to economic forecasting. It will be helpful to use this lens as you read through this brief blog.
In different seasons or phases in the stock market, investors develop narratives and analogs to compare today’s situation with some timeframe in the past. History doesn’t typically repeat itself exactly, but it often plays out with similar broad strokes. Studying stock market history is a valuable tool to help with decision making if you can identify some of those broad strokes as they are happening. The business cycle is a key piece of these observations – the four phases of which are: expansion, peak, contraction, and trough. The impetus that drives the economy from an expansion to a contraction is almost never the same, some that come to mind are: Covid lockdowns (2020), Great Financial Crisis (2008), and the Dot-Com Crash (2000). While these are very different catalysts that drove the US economy from expansion to contraction – they all played into the business cycle (Covid being somewhat of an outlier to this). With this in mind, we wanted to give our take on where we think the consumer is right now and the implications for the business cycle and ultimately how this is all influencing our current investing approach.
We are going to use the 1990’s as our comparison because many are comparing the current market rally based around artificial intelligence with the Dot-Com boom and bust in the 90s into the early 2000s. The bulls would say we are living in a 1995 scenario right now where a soft landing is assured and there could be 5 more years of hype and investing gains to be enjoyed from artificial intelligence (AI) before we get into a “bubble” type situation. Some bears would say the hype around AI has already driven markets into bubble territory and that it could burst soon. We aren’t in either of these camps. We think valuations in the market are rich right now and are due for a pullback, possibly a significant one, but valuations themselves are nowhere near the levels reached in the late 90’s. The macroeconomic environment today is also vastly different from the early and mid1990’s.
Let’s look at some examples, and keep in mind, a soft landing is what happens when inflation returns to the Fed’s target of 2% without pushing the economy into a recession. In our opinion, the jury is still out on this, but the market has run away with the idea that a soft landing is currently a given. That’s one reason why we think a pullback is due for the market – to give some probability back to a slow-down or harder landing.
Notes on the 1990’s Macroeconomic Environment:
Real GDP growth ranged from 4-5% from 1995-2000. Link
Unemployment was over 7% in 1992 and was at about 5.8% in 1995 and gradually moved lower until it reached 3.8% in 2000 before moving back up. Link
PCE was at 2% in 1995 which allowed for a dovish Fed pivot and soft landing. Link
Inflation stayed low for several years to early 2000 in part due to globalization and geopolitical stability.
The geopolitical landscape supported high-growth and low inflation.
The employment situation was ideal for expansion – falling unemployment, but not such low unemployment that it became inflationary, at least until the end of 2000.
The inflation scenario was ideal for several years as globalization occurred and production costs could come down as a result – producing goods in China and other countries where labor costs are lower compared to the US.
No inverted yield curve.
US Government reached a surplus in the late 90’s. Link
Notes on 2024’s Macroeconomic Environment:
Unemployment was at 3.7% in January and just moved up to 3.9% in February. Link
There are a lot of reasons for the low unemployment rates in the last year or two, mostly related to Covid. What we are getting at with this number is the fact that unemployment is at historically low levels, which means there isn’t much room to go lower and drive further expansion. It’s starting to move higher now which is the wrong direction for continued expansion.
Inflation is still above the Federal Reserve’s target and is possibly headed up again after many months of gradually moving lower. Link
Deglobalization is underway which is inflationary and seems to rely heavily on government spending – the opposite of what was mentioned above. Moving production back to places that have higher labor costs – supply chain onshoring.
US government is facing an unsustainable increase in debt and deficit. All of this will likely be inflationary.
Yield curve inverted for the past 17 months. Link
Average weekly hours of all employees are down to levels that are typically only seen in and around recessions. Link
Some notes specifically on the consumer in 2024:
3.6% of plan participants took 401k hardship withdrawals up from 2.8% in 2022 and the pre-pandemic average of around 2%. Link
In the article linked they also mentioned that 40% of those hardship distributions were taken to avoid foreclosure compared with 36% in 2022.
Credit card balances grew faster than spending in 2023. Link
Credit card delinquencies at highest levels since 2011. Link
Auto loan delinquencies at highest levels since late 2010. Link
Overall, we think the macroeconomic environment is very different from 1995 which makes it difficult to believe there could be several more years of expansion just based on hype around AI. Looking at the fundamental data, it seems more likely that we are closer to the end of the business cycle than early or mid-cycle. The consumer seems to have gone through several phases of spending such as - stimulus money and savings, to then running up credit card balances, and now we are starting to see hardship withdrawals from 401k accounts beginning to tick up. That’s a concern for us when assessing the health of the consumer – the driver behind 70% of the economy. Couple all this information with the behavior in the markets in recent weeks and we think there is very good reason to be cautious, which is why we have oriented our investment strategies to be prepared for a pullback in stocks. What we mean by recent behavior is a significant “risk-on” mentality that’s taken hold and seems to take any news as good news regardless if it’s good or bad. That tells us investors have very little fear right now, which isn’t always a bad sign in isolation. However, there are significant downside risks we think are currently being ignored and that could lead to a sharp correction because the complacency in the market can quickly turn into panic.
History has shown us that when everyone is on the same side of the boat – it can lead to some rough times and as your portfolio manager – we take this responsibility very seriously. A correction in the market to reset valuations would be very healthy and provide a new lens in which we could see some exciting opportunities going forward. We wanted to communicate with you, so that you would know we are paying attention to these things and trust this information has helped you in understanding some of what we are doing at the moment and what we intend to do as things continue to develop.
Authored by: Michael McCracken CFP®, ChFC and Jeffrey Gardner, Financial Advisor The information presented above has been prepared for informational purposes only and the commentary represent the opinions of the author and are subject to change at any time due to market or economic conditions or other factors.