This recovery cycle has been both longer and weaker than in the past. This chart shows long-term (5-year) rates of change, over a long period (since 1973) in three key indicators: Productivity, wage growth, and GDP growth. You can see all three are now tepid at best compared to their historical averages.
A decade of bailouts and dovish monetary policy didn’t revive previous trends. This doesn’t say recession is imminent. The US economy is still growing by most measures. However, the growth is slowing and, unless something restores it, will eventually become a contraction. The US economy, not to mention the global economy, is in a vulnerable stage. It won’t take much of a shock to push it into recession.
The inverted yield curve is one of the more reliable recession indicators.
But, even the nominal yield curve shows a disturbingly high recession probability. Earlier this month, the New York Fed’s model showed a 33% chance of recession in the next year.
The Cass Freight Index, which I have followed for more than a decade, measures shipment volume (by quantity, not cost) across the economy: truck, rail, air, ship, everything. The chart below shows its year-over-year percentage change.
Do I blame this on Trump’s trade war? Partially, yes, but I think more is happening. Years of flat wages forced many households to take on more debt. This has a cumulative effect; you can handle the payments for a while, but eventually things happen. Rising interest rates didn’t help.
What does all this mean for your investments? It probably won’t be good for stocks, unless you have a two-sided strategy, which we do. Stock valuations are historically high relative to our actual income. You might recognize that as Warren Buffett’s supposed favorite indicator: the ratio of stocks to gross national income.
Here is how to read the chart:
- First, focus on the bottom section of the chart. The red line tracks the ratio since 1925.
- Above the green dotted line is the top quintile, or most overvalued, in terms of stock market price to income. Below is the bottom quintile, or where bargains are best. The red arrows mark prior peaks in valuation (1929, 1966, 2000, 2008, and today).
- Next, look at the red rectangle in the upper left-hand section of the chart. Focus in on the yellow circle. It shows the subsequent five-year return achieved when the ratio was in the top quintile (most overvalued) and was just 1.41%. That is the total return after five years, meaning your $100,000 grew to just $101,410. Annualized, that is a compounded return of approximately 0.22% per year. Not good. The 10-year return was just 50.66%, which is an annualized compounded return of approximately 4.25%. Not so good.
- Now look at the subsequent 5- and 10-year returns when the ratio was in the bottom quintile (most undervalued). +123.87% average five years later and +367.36% 10 years later. Pretty great.
- NDR (Ned Davis Research) said that no indicator they have tested has done a better job historically at showing subsequent 5- to 10-year returns. We should take note.
The Problem is Worldwide Manufacturing, NOT Services
The preliminary Markit PMI report showed that growth in factory activity stalled in July.
The services PMI rebounded from the recent lows.
Here is the Divergence in Germany, For Example
Here is the services – manufacturing PMI divergence at the Eurozone level.
How Does Gold Do In Bear Markets?
1970 – 1974 Bear Market:
Bear Market of 1999 – 2003:
Bear Market of 2007 – 2009:
The “Bad Is Good” Deception
In 2015 and 2016, economic surprises—good news about this or that with the economy— were good for stocks, and the markets climbed
higher. Today, that correlation has been turned on its head. Good news is interpreted as bad for stocks as it may mean the Fed will be less inclined to lower interest rates, or otherwise take actions that are market supportive.
Market Data
- Over the past 30 days, there have now been 6 sessions when the S&P 500 was at or near a 52-week high, but the ratio of the small-cap Russell 2000 index to the S&P sunk to a 52-week low. That’s the tightest cluster of days since April 1999.
- We’ve focused a lot on a split in the market, which has developed in recent days. Now 4 of the past 5 sessions on the Nasdaq have triggered a Titanic Syndrome, a new high in the Composite followed quickly by more 52-week lows than highs on the exchange.
