With Market Indices at or Close to All-Time Highs, Investors Puzzle Over the Course Ahead. Meanwhile, The Slow-Growth Economy Is Perceived as the New “Goldilocks Scenario.”
A colleague recently told me that his 12-year-old son asked, out of the blue, “Hey Dad, do you watch Cramer?”—referring to Jim Cramer of CNBC’s Mad Money show. This anecdote reminded me of the legendary tale about Joe Kennedy exiting the stock market after a shoeshine boy offered up unsolicited stock tips. It was just days before the October 1929 crash. Taxi drivers, servers in restaurants, youngsters hawking newspapers and elevator operators also shared their favorite stock ideas. To the wise, these touts offered a cautionary sign.
Elevator operators—among many other professions—may have largely disappeared from the economic landscape. But many perceive that cautionary signs abound today. You don’t have to look far to find investors who’ve largely withdrawn from the markets, rattled by political surprises in the U.S. and abroad, all but certain that the current economic expansion—now the third-longest since the end of World War II—will soon come to an abrupt end.
While I think some concerns—including high equity valuations and rising debt levels in the U.S.—are valid, letting them dominate the investment process isn’t productive. In past messages, I’ve pointed to Warren Buffett and Howard Marks as strong advocates for continuing to invest, albeit carefully.
Unlike Cramer with his gimmicky sound effects and shouts of “Booyah!” and unlike the shoeshine boy with his up-to-the-minute stock tips, I offer no predictions about the short-term direction or magnitude of the markets’ movements. But I continue to believe that Wasatch’s long-term approach—based on finding companies that have competitive advantages, that are taking market share and that are growing revenues and earnings at attractive rates—will enable us to ride out difficult periods and serve our shareholders well over time.
While it’s certainly possible that an unforeseen event could precipitate sharp declines in the economy and the markets, it’s hardly a given that the economy and the markets would then suffer sustained damage. As evidence, I suggest you look no further than the past 12 months or so. Despite dire predictions that voters’ approval of Brexit would create chaos, British stocks overall are significantly higher than before the Brexit referendum. Similarly, though investors panicked following the election of Donald Trump, stocks quickly rebounded despite many obstacles.
The usual measures of economic health present a mixed picture in the U.S. At 4.3%, the unemployment rate reported for May was the lowest in 16 years. While the unemployment rate for June edged up to 4.4%, a greater number of jobs than expected were added to the economy. The rate rose as even more workers were added to the labor force, an encouraging sign. The labor market has been tightening, but so far putting little upward pressure on wages. Inflation, at an annual rate of 1.9% through May, was still below the Federal Reserve’s (Fed’s) target of 2.0%. And U.S. gross domestic product (GDP) grew at an anemic annual rate of 1.4% in the first quarter, with forecasts for the second quarter little better.
While the Fed raised the federal-funds rate in June by a quarter point, central banks in Europe and Japan have kept benchmark interest rates near zero. And although the Fed has raised short-term rates, longer-term U.S. government bond yields have fallen close to their lowest levels of the year. The yield curve has flattened, creating smaller differentials between short-term and long-term yields.
In the past, I’ve warned that investors in long-term bonds face large principal losses if interest rates rise significantly. And that warning is still relevant today. But with 10-year government bonds in much of Europe and Japan yielding significantly less than 1%—and with 10-year U.S. Treasury bonds already yielding a much higher 2.4%—I can also envision a scenario in which U.S. rates confound the pundits by failing to rise as much as generally expected.
Oil prices, meanwhile, have declined more than 20% this year. Although that’s been a boon for summer travel and consumers, it’s taken a toll on energy and related stocks.
A consensus is emerging that the slow growth characterizing the current economic expansion, rather than presenting a problem, is actually a new “Goldilocks scenario.” In other words, the economy is neither too hot nor too cold—sustaining moderate growth, low inflation and rising asset prices. It’s becoming apparent that slow growth provides ample time for the economy to adjust to changes that might otherwise develop into excesses in a faster-growth environment. Previously seen as a source of frustration, the slow-growth economy is gaining acceptance as the unemployment rate continues to decline and help-wanted signs become more prevalent.