2/16/2016 – It is well known that there is considerable concern for the global economy. Red flags are flying high: credit spreads have widened, China is slowing down, inflation levels are almost nonexistent, corporate earnings have stalled, and developed economies are adopting negative interest policies. The fear here in the United States is that the global slowdown will eventually impact us here. While history may not repeat itself, it certainly does rhyme. I’ve read many pieces where our current slowdown is compared to that of the Great Financial Recession of 2008/09 and to that of the Tech Bubble of 2000. I agree that there are similarities, but there are distinct differences.
There are many factors behind the 2015/16 risk asset class selloff: higher equity prices, lower oil prices, a stronger U.S. Dollar, high levels of margin debt, sputtering global growth, etc. However, the biggest reason why risky asset classes are underperforming (in my opinion) is due to the lack of easy money. U.S. Quantitative Easing ended in October 2014. Remember, the purpose behind QE was to inflate asset prices by incentivizing investors to invest outside of “safe” assets (e.g. Treasury bonds, cash deposits, etc.). This worked wonderfully from 2009 to 2014. However, the U.S. large-cap market has really had a difficult time finding any legs following the conclusion of QE.
As it currently stands, the U.S. stock market has to stand on its own two legs. This means that earnings have to justify its current price. And it hasn’t performed very well. With the other major global central banks continuing with a loose monetary policy (in contrast to the Fed adopting a tighter policy), the U.S. Dollar has skyrocketed. As a result, the stronger dollar has had an enormous impact, not only on corporate earnings, but also U.S. manufacturers that exports goods and services.
Additionally, the stronger dollar has coincided with falling oil. Nobody knows whether or not the USD impacts oil, or if oil impacts the USD, but it is clear that they currently have a negative correlation. I’ve written more about this here. Nevertheless, falling oil prices has forced many shale oil producers to cut expenses in an attempt to maintain solvency. This, of course, includes laying off workers in many oil producing states (e.g. Texas, North Dakota, etc.).
Keep in mind, though, that U.S. manufacturing and shale oil producers are not representative of the overall U.S. economy. According the World Bank, value added manufacturing accounts for roughly 12-13% of the overall U.S. GDP. Significant, but not critical. Oil and gas CAPEX represent less than 1% of U.S. GDP.
So, why has fear escalated here in the U.S.? Employment gains has remained stable. The unemployment rate, currently at 4.9%, is near historic lows. We have even seen a tick up in wage growth. In short, the U.S. consumer is strong.
This is very good news as this is in direct contrast to the 2008/09 financial crisis. During the Great Financial Crisis, the U.S. consumer was directly impacted. The early signs back then were lagging coffee sales and retail shopping began to slump. As it currently stands, I would argue that the U.S. consumer is the last remaining bull in a bear market. And what an important bull it is. U.S. consumption accounts for 70% of U.S. GDP. As long as consumption in the United States continues to thrive, I will continue to pursue with my plan to become more opportunistic in the near-term.
This brings me to my final point: All bets are off if the U.S consumer loses this position of strength. A stronger dollar means that imports are cheaper. Lower oil prices means that more money can be saved at the pump, which equates to more money spent elsewhere (eating out, usually). Unlike the 2008/09 financial crisis, US consumers are not ladened with debt. Nor are they being forced to liquidate assets in order to pay for everyday necessities. However, this can change if conditions do not improve. As I said earlier, corporate revenues and profits are declining. If U.S. companies are forced to make expense cuts, this can include laying off employees. Likewise, if the cost of debt continues to climb, this will limit corporate investments and will ultimately impact the labor force. I know this sounds a bit bearish, but I cannot ignore the fact that the U.S. labor market is the only reason why the bottom hasn’t fallen out from beneath the stock market. I remain optimistic, but also realistic.
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