Is it too early to call an economic top?

[orthopa]

I'm well aware of the wall street adages of predicting recessions and how money can be lost but the way the US market and markets around the world are "acting" makes me think growth is slowing and we may have seen the peak at least in the economy for a while. At the risk of getting into a wordy disseration but with PMI readings, employment, consumer sentiment, and the stock market at all time highs in the face of rising rates it seems at a minimum peak growth maybe behind us.

 

The market is up single digits to date and although valuations are not extreme this was on top of a huge stimulus tax package. 2019 we lap that and are things going to be that much better with the effects of the tarriffs and higher cost debt? What happens to the economic indicators then?  We hear out of Washington everyday that growth is accelerating and best ever. Best ever is almost always near the top. Every other stock market is getting crushed and the Fed still has a huge bond portfolio to unwind.

 

At a minimum we will see the wealth effect take a turn for the worse with rates rising, lower stock market valuations and in turn decreasing home prices. Housing is already slowing down due to rates and the SALT tax exclusion.

 

Im by no means calling a market top but someone famous once said its better to be roughly right then precisely wrong. At a minimum 12 months from now its not unreasonable to think a market devaluation due to multiple compression (pick a number, 5-10%) is coming. We saw it today in tech and FB earlier this year. The high flyers are coming down.

 

I promised myself after 2008-2009 to not stick my head in the sand when things got too good. At a minimum I think a healthy caution is warranted and I know myself Im going to have to really readjust expectations for growth and valuation over the next couple of years.

 

Thoughts? How much better can it really get?

[Spekulatius]

Actually, i think market performance and GNP growth arnt necessarily correlated. We are starting to see increases in labor costs and going forward most likely inflationary pressures from the trade war, which in addition to interest rates aren’t necessarily good for the stock market.

 

I believe we could see falling stock prices even if we don’t have a recession, simply due to multiple compression ( higher interest rates) and a reduction in profitability (due to inflationary pressures).

[DTEJD1997]

I've been wondering for a while where we are in the economic cycle...

 

Here in the USA, I've come to the conclusion that different parts of the country are in different parts of the cycle.  For instance, NY & CA, which probably came back relatively quickly from the Great Recession, might be ready to start going downhill.  Not all parts of the country have been in an economic recovery for 10 years.

 

Here in MI, the state has been in the doldrums for YEARS after 2008.  It is really only the past 1-2 years that things have really started to pick up.  Hiring is up, wages are up.  Wages & hiring has been only the past two years.  Two years ago, hiring started to pick up.  About a year ago or so, wages started to go up. Property values have been up...but they have been going up for 3-4 years. Property started going up BEFORE hiring and wages.

 

There have been some "goofy" things going on with real estate.  For example, there are some nicer houses in Detroit that have probably gone up 10X in the past 5 years.  I've seen some houses that have gone from $40k to $290k.  I don't think things are going to end well for those home buyers.

 

Almost all property in Detroit now has some "value" attached to it.  It is hard to find "zero" or negative worth properties.  There is an incredible influx of "investors" or speculators.

 

So I think that MI is a "lagging" state.  I really hope that here in MI, we don't have just 1-2 of really good years.

 

As to other parts of the country, people are most certainly doing better...but I still know PLENTY of people who are not yet back to their peaks back in 2008/2009.  I suspect that some of those people unfortunately will never make it back to where they were.  Some people were damaged just too much.

 

If we could get another 4-6 quarters of good growth/good economy, it would allow a lot of good for a lot of people, all across the country.

 

 

[Viking]

It is exceptionally difficult to time the market. As of today, the US economy is performing exceptionally well. None of the leading indicators are flashing even yellow. Yes, there are issues but there always are issues. The current concern is rising rates, on both ends of the curve. And there is a trade spat with China.

 

Is a big sell off coming? Perhaps. I really have no idea.

 

The key is can you sleep at night? If not, something is likely wrong with your portfolio.

 

As long as the US economy continies to chug along I am going to be patient with my holdings.

 

All of the negativity actually makes me more positive on stocks. And we also will be having an election in the US in 4 weeks and a bear market is stocks will not be good for Trump so i expect he will not let it happen :-)

[DooDiligence]

 

It is exceptionally difficult to time the market. As of today, the US economy is performing exceptionally well. None of the leading indicators are flashing even yellow. Yes, there are issues but there always are issues. The current concern is rising rates, on both ends of the curve. And there is a trade spat with China.

 

Is a big sell off coming? Perhaps. I really have no idea.

 

The key is can you sleep at night? If not, something is likely wrong with your portfolio.

 

 

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I lose no sleep and have other, more immediate, things to worry about...

[thowed]

a bear market is stocks will not be good for Trump so i expect he will not let it happen :-)

 

This is the sort of thing that makes me nervous - when we're all conditioned that things can't go wrong because there's a permanenet safety net (see also: the Fed will print more money etc.).

 

However, totally agree about sleeping well at night with the right portfolio, as long as one doesn't get over-confident about it.

[StevieV]

Actually, i think market performance and GNP growth arnt necessarily correlated.

 

I saw a chart on this just a few days ago.  I'll link it if I find it again, but GDP to S&P correlation has historically been very, very low.

 

Regarding this thread generally, I have no strong opinion on whether the economy or the S&P 500 will turn over.  Doesn't seem like the economy is on the verge of major problems, but who knows.  I've got even less of an idea regarding the S&P 500.  I tend to think a pause or correction in the market coupled with continued growth in the economy would be fine.

[Liberty]

Some counterpoints:

 

http://scottgrannis.blogspot.com/2018/10/just-another-panic-attack.html

[SHDL]

Hard to say...  In terms of the general US stock market I personally do expect pretty mediocre/bad returns going forward, but that doesn't mean it can't keep going up 2% per year for 10 years, in which case where we are today would not be the "top." 

[wabuffo]

Some counterpoints:

http://scottgrannis.blogspot.com/2018/10/just-another-panic-attack.html

 

Great economics blog - thanks for the link.

 

wabuffo

 

[Liberty]

Hard to say...  In terms of the general US stock market I personally do expect pretty mediocre/bad returns going forward, but that doesn't mean it can't keep going up 2% per year for 10 years, in which case where we are today would not be the "top."

 

People have been predicting mediocre forward returns (the new normal of low returns) since around 2011.

 

I think it's very hard to predict the future, but it makes people feel conservative and like they're being safe when they predict mediocre returns.

 

In reality, who knows what will happen?

[CorpRaider]

To me you have to be evidence-based and systematic when it comes to this type of stuff (and most things actually).  Otherwise you run a huge risk of fking up your portfolio and your psyche.

 

I do tinker with a value + trend/momentum system in of my accounts (unless stocks are expensive and in a not in an uptrend, I want to be long).  Out of U.S. stocks in that one as of today. 

 

[TwoCitiesCapital]

Hard to say...  In terms of the general US stock market I personally do expect pretty mediocre/bad returns going forward, but that doesn't mean it can't keep going up 2% per year for 10 years, in which case where we are today would not be the "top."

 

Yes this COULD happen, but seeing as that is never how we've gotten to low decade returns in the past suggests that it's unlikely going forward. It just doesn't jive with the human psyche - we are either overly optimistic or overly pessimistic. Very rarely are we "just-right" or "just easing back" for a decade to get the require environment to support consistent 2-3% annual returns. More likely you get a big top and then a big bust.

 

January looked like a blow-off top to me - 10% in a single month for U.S. and International stocks?!?!? The only thing that has had me questioning that was the fact we made new highs after that. I'm not all that well versed in the rules of technical analysis, but I wouldn't have expected us to slowly grind higher to new highs like we did if January was peak-euphoria. Not saying we haven't already seen the top - just that I'm inclined to believe January was "really" it while trying to remain somewhat skeptical of that since markets don't see to agree with me.

[meiroy]

Yes. But, we are all going to die. So, eat and drink and be merry.

 

[John Hjorth]

Hang Sen looks down this morning, while European indices in general are in black this morning.

[SHDL]

One exercise I like to do when assessing general US market conditions is to run a few simple IRR projections for a buy-and-hold-forever investment in the S&P 500 and compare the numbers with current long term bond yields. 

 

To do this you need to have some notion of what the future ROE and real earnings growth rates are going to be for the S&P, and of course nobody knows for sure what those are going to be, but since they have historically been in the mid teens and low single digits respectively over long horizons (without any obvious increasing or decreasing time trends), I tend to assume something like ~13% for the former and ~3% for the latter.

 

Anyway when I did this exercise recently I got IRR estimates in the 3-7% range adjusted for inflation. Now that is by no means terrible, but it is certainly below its historical average, and it is not particularly attractive either when compared with, say, the yields you can get on certain long term investment grade corporate bonds (already in the mid single digits, and likely to go up a bit more in the near future).

[SHDL]

Some additional comments:

 

1

 

In case somebody’s wondering:  Yes there is some empirical basis for this type of “forecast.”  In short, the IRRs estimated like this are highly and positively correlated with the inverse CAPE ratio and so they inherit the latter quantity’s predictive power with regard to future long term stock returns.  And when IRR estimates have fallen as far as they have now, future stock returns have tended to be in the low single digits on average after adjusting for inflation.

 

2

 

What Liberty said is of course also true — nobody really knows anything about the future. (In fact I can’t even predict what I’m going to have for dinner tomorrow…)

 

But if you do this type of calculation and data work you’ll see that you will need some pretty serious deviations from historical norms to get, say, double digit real returns on the S&P over the next 10-20 years.

 

3

 

I had the same feeling as TwoCitiesCapital — that a crash followed by a recovery was more likely than a long stream of consistently low returns — and I am happy to report that I was actually able to find some evidence supporting this view. 

 

That being said, long term dead money in equity markets is not entirely unheard of (e.g., the Nikkei 225 — oh, the horror!).