Less than three months ago, analysts everywhere argued a case for economic acceleration. It was almost as if financial authorities big and small had held a convention at LEGOLAND in California to declare that, “Everything Is Awesome.”
Everything is not awesome. Jobless claims hit 10-month highs, factory orders have dropped for six consecutive months, consumer spending has been waning, exports have been declining and demand for raw goods as measured by shipping rates have been notching historical lows.
In fact, the only thing that can genuinely be described as wonderful are investor account values. The Vanguard Total Stock Market ETF (VTI) remains within one percentage point of a brand new record and the Vanguard Total Bond Market ETF (BND) has been in a long-term uptrend since the start of 2014. Any traditional asset allocation mix has bolstered the wealth and well-being for those with 401ks, IRAs and brokerage accounts.
Nevertheless, there is a disconnect between investor expectations and economic realities. If one expects an economy to accelerate, one may conclude that corporations will generate more revenue and more profits, thereby justifying increasing prices for stock shares. If one expects economic deceleration – if sales and profits are not even expected to grow on a year-over-year basis – one might anticipate equity prices to remain range-bound.
However, stocks already command sky-high premiums. Moreover, the Federal Reserve appears determined to normalize interest rates which might cause the economy to grind to a halt. It follows that equities may fumble on the way to flatness, eventually pulling back 10%-15% at some point in 2015. Rare is the historical circumstance when decelerating economic activity and overvaluation did not combine to cause a stock market correction. Mix in a policy misstep by the Federal Reserve or a crisis abroad, and the probability of a bearish outcome increases.
Six years of quantitative easing (i.e., QE1, QE2, Operation Twist, QE3) and zero percent rate policy guided the U.S. economy toward an average growth rate of 2.2%. That is well below the 3% longer-term average. What is particularly disturbing about this truth is that – since QE3 ended on 10/29/14 – the overall economy has steadily weakened. What happened to the notion that the economy is “self-sustaining?”
Most folks expect the Fed to push off rate hikes into the 4th quarter, giving them reason to keep buying stocks on every modest dip from all-time peaks. Indeed, even if the economy became fragile enough to stoke recessionary fears, most seem to believe that the Fed would backtrack to the point of providing additional rounds of QE stimulus. The message? Don’t stop buying and don’t stop believing in the Fed.