- Goldilocks versus the Bears: Small Business Optimism Index Rises
- Household Debt-to-Income Ratio Remains Low
- Vanguard Joins the 40% Club with Recession Prediction
- Looking Ahead: Home Sales, Durable Goods, Fed Meeting
Turkey’s currency crisis, provoked by political posturing, sparked fear of an emerging markets contagion earlier this week. But by Friday, investor anxiety was contained, as U.S. stock markets rallied and the toll on foreign markets was smaller than expected.
Helping to offset emerging markets concerns was the ongoing stream of healthy U.S. economic reports that continued to reflect a steady-as-she-goes, slow-growth economy driven by confident and financially stable consumers.
For the year through Thursday, the Dow Jones Industrial Average has returned 4.9%, while the broader S&P 500 has gained 7.6%. The MSCI EAFE index, a measure of developed international stock markets, is down 4.3%. As of Thursday, the yield on the Bloomberg Barclays U.S. Aggregate Bond index was 3.30%, up from 2.71% at 2017’s end. On a total return basis, the U.S. bond market has declined 1.1% for the year.
Goldilocks versus the Bears: Small Business Optimism Index Rises
The not-too-hot-not-too-cold earnings, interest-rate and economic data continue to support a reasonable pace of U.S. growth, creating an environment where jobs are plentiful and confidence is high. The result: Consumers have been spending freely this summer. Spending rose for the sixth month in a row in July as restaurants, brick-and-mortar stores and online retailers all saw higher demand. For the 12 months through July, sales increased 6.4%. With back-to-school shopping season beginning, and July and August marking two of the biggest vacation months of the year, spending momentum appears on track to power further economic growth.
This hasn’t come as a surprise to small business owners. The National Federation of Independent Business’ small business optimism index rose last month to the second-highest level in the survey’s 45-year history. Proprietors reported record job creation plans and job openings, but their main concern over the last year or so is a growth problem—the lack of qualified workers.
Household Debt-to-Income Ratio Remains Low
A burst of negative and misleading press concerning the total indebtedness of U.S. households showed debt reaching a record-high $13.3 trillion in the year’s second quarter. Comprised of mortgages, car loans, consumer loans and more, excessive household debt is deemed problematic for ongoing economic growth. But while true that household debt reached a record, what was missed in most press reports was the fact that incomes—which enable people to take on new debt or pay off old—have also risen. That fact was not overlooked by us.
The Federal Reserve publishes a ratio that captures this trend, and it shows that household debt compared to income has come down to a reasonable level after running up during the housing bubble and into the financial crisis in 2008–2009. In fact, the household debt-to-income ratio has fallen to levels last seen in 2002.
Vanguard Joins the 40% Club with Recession Prediction
In the August 12 edition of The New York Times, you may have seen Vanguard’s prediction, hardly unique, that the prospects for a recession are growing. Let’s break it down.
First, Vanguard put the probability of a recession by late 2020 at 30% to 40%. If you believe that an inversion of the yield curve—where short-term bonds begin to out-yield longer-term bonds (which has not happened yet in this expansion)—always precedes and predicts a recession by an average of 16 months or so, Vanguard is calling for the yield curve to invert by the end of the year, give or take, as mid-2020 is 16 months from the end of 2018. Saying “late 2020” gives them some leeway, but they aren’t going too far out onto a limb.
That said, Vanguard Chief Investment Officer Greg Davis is quoted in the article saying, “We don’t make any actual predictions about where things are going next month or, in the markets, next year… We don’t know.” That’s not exactly a ringing endorsement for their forecast.
In fact, another Vanguard manager quoted in the same article notes that the 30% to 40% probability of a recession in 2020 also means that there is a 60% to 70% probability that they will be wrong.
Count us unimpressed. We take that 40% prediction with a big grain of salt. Earlier this year, The Wall Street Journal highlighted the “40% Rule” as a common gambit for those in the predictions game. Essentially, by calling for a 40% chance of something occurring you look smart if it does happen, but if it doesn’t, you’re still on record as saying that the odds were against it.
The important point here is that Vanguard is getting lots of free publicity for making a useless prediction, based primarily on the flattening of the yield curve. We happen to believe there is a 100% chance of a recession sometime in the future—we just aren’t pinpointing when it will start. As Yogi Berra supposedly once said, “It’s tough to make predictions, especially about the future.”
Looking Ahead: Home Sales, Durable Goods, Fed Meeting
Next week’s reporting slate is another relatively light one. We’ll be looking closely at data on new and existing home sales and durable goods orders, as well as minutes from the Federal Reserve meeting two weeks ago and potentially some notes and quotes from the attendees of the Fed’s annual Jackson Hole Economic Policy Symposium.
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Please note: This update was prepared on Friday, August 10, 2018, prior to the market’s close.
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