Of course, the “surprise” index simply evaluates data relative to economists’ estimates. Doesn’t that mean that forecasters were too optimistic about the economy as we entered 2015? Yes. Doesn’t it also mean that there is little reason to worry about the possibility of a recession? Hardly. The Federal Reserve Bank of Chicago publishes a monthly National Activity Index (CFNAI) that gauges the overall well-being of the U.S. economy. The CFNAI employs 85 indicators that span employment, unemployment, hours, consumption, housing trends, sales, orders and inventories. Not only is the CFNAI currently negative, its heralded 3-month moving average descended from to –0.27 in March from –0.12 in February. Simply stated, we are moving in the wrong direction and we are inching closer to contraction.
So why is there so little fear on the part of the investing public? For one thing, the U.S. Federal Reserve and the Federal Reserve Open Market Committee Members (FOMC) – the people who determine how and when to make changes to rate policy – value the Chicago Fed’s National Activity Index. Voting members recognize that the economy has been weak and it is showing signs of getting weaker. In essence, there’s virtually no chance that committee decision-makers will raise borrowing costs anytime soon.
Keep in mind, however, history has rarely been kind to stocks when economic growth is decelerating and earnings growth is stalling. Record stock highs in this environment begs the question, “How much faith in central banks is too much faith?” Granted, my clients are riding the central bank intervention wave with allocations to funds like iShares Currency Hedged MSCI EAFE (HEFA) and WisdomTree Europe Hedged Equity (HEDJ). Moreover, we’re still holding long-time winners like iShares USA Minimum Volatility (USMV) and SPDR Select Health Care (XLV).
Nevertheless, I understand the value of multi-asset stock hedging; that is, late-stage bull markets require an allocation to non-stock assets that can perform well in bearish sell-offs as well as during times of economic uncertainty. Currencies such as the Swiss franc and the U.S. dollar tend to appreciate, even when the central banks of those countries may attempt to counter those trends. Long-term U.S. Treasuries tend to rise and yields tend to fall, even when our Federal Reserve waxes philosophic about “normalizing” the yield curve. Not only is the yield curve flattening, but the iShares 20+Year Treasury Bond Fund (TLT) remains in its long-term uptrend.