Wall Street Cries Wolf
There is no question that the stock market is richly valued and the economic expansion since the 2008 mortgage debt panic has endured far longer than normal cycles. Recent pessimism has arisen with major banks and analysts warning that the sky may start falling soon. Increased negative forecasts can be a positive contrary opinion signal, so let’s look at some of the concerns the major bulge banks are propagating.
Recently, $30 billion in funds flowed out of US equities and the current mid-2017 outflow is at record levels, which is being portrayed as a scary signal of impending doom. Oddly, past extreme spikes in fund outflows were good times to begin buying stocks. In particular, the two most impressive rush for the exits occurred in mid-2004 and early 2016. In hindsight, these were a couple excellent points to buy stocks hand over fist. Apparently, many institutions equate this extreme proxy of equity fund outflow and today’s high priced stock market as a valid correlation when their own evidence would indicate otherwise.
The fall in car sales in 2017 has caused alarm that consumers are financially depleted, which will take the wind out of this economy. A contraction in the auto sector is definitely a near-term concern, but how unprecedented is the 2017 decline?
Current purchase rates are still healthy at more than 17 million. Past plateaus in car sales seem to occur every 10 to 15 years and can spend years gyrating in 10 to 20% ranges before a true auto sector contraction arrives. Annual sales rates contracting from just over 18 million units to well under 16 million would be “normal” even if this business cycle expansion were to continue several more years. What we know is that job creation continues, consumer debt service ratios are very favorable for spending, and loan default “rates” are very low. However, a cyclically large number of leased cars are flooding used car inventories along with a normal slowdown in car buying after an 8-year easy credit spending spree. It will take more time to work down bulging car inventories, but with global growth picking up speed and healthy consumer balance sheets, it’s likely sales will bottom out this year and enter a trading range pattern in sales for 2018. While we would continue to avoid stocks of the US big 3 auto producers, it’s interesting that the high-end car market has been accelerating this year despite the lull in more mundane car makers. Long term, the secular trend in autos is suspect over the next decade as the global government mandates for hybrids and all-electric vehicles along with ride sharing trends serve to curtail normal driving patterns and car purchase rates.
An inverted yield curve is where short-term rates rise above longer term yields. This indicator has an almost unmatched accuracy in calling major economic cycle peaks prior to recessions. For banks to highlight the narrowing yield curve instead of actual inversion seems to support the idea that these esteemed wealth managers are desperately reaching for unproven clues to fit their preconceived notions of alarm. Past periods when the yield curve has fallen to current levels have not been a time to be alarmed. In fact, they were moments when investors should bet on further gains in stocks and the economy. In a historically slow growth world without inflation worries, we should expect lower interest rates and flattening yield curves with less correlation to economic overheating as in the past. Should we reach the nadir of this chart with an inverted yield curve, we will discuss the potential for ringing alarm bells, but for now a flatter yield curve would be a sign the lukewarm economy is gaining steam that has been absent for almost a decade.
We often highlight warning signs that are missing when looking for economic peaks that have appeared near past economic tops. Indications of financial stress typically hint well in advance of major trouble. At current levels of low stress, it seems premature to expect an economic downturn or anything other than a period of short-term stock market trepidation. Before we worry about economic contractions it would be normal to expect a year or two of above trend GDP growth > 2%, rising interest rates, credit tightening and elevated levels of stress.
About Kurt Kallaus
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