While the situation in Cyprus will likely dominate the market on this fine Monday morning, I have decided to step back across the pond and focus on the macroeconomic forces as it relates to the stock market here at home in this morning's missive.
While I tend to ramble on at times in this space, I think I can sum up the current situation in the U.S. stock market with the following: Goldilocks vs. The Three Bears. I know what you're thinking. He isn't really going to do an analogy of the age-old fairy tale, is he? To set your mind at ease and to encourage you to continue reading, the answer is no.
My message this morning revolves around the idea that the market is enjoying a “Goldilocks” type of environment from an economic standpoint at the present time. The economy isn't “too hot” so as to produce concerns about inflation, which would force the Fed to change horses in the middle of the race. And yet at the same time, the economy isn't “too cold” enough to cause any real concerns about the U.S. slipping back into recession. So, with the Fed keeping rates low, no real inflation concerns, record earnings, fair valuations and an economy that is improving, the bulls would seem to have the edge right now from a big-picture standpoint.
I know that the bears would have you believe that we are a missed EU deadline away from the U.S. economy stopping on a dime and sliding into recession. However, in light of the fact that we review every single important piece of economic data that is released in real time around here, I can tell you that this concept is sheer folly right now. The U.S. economy is “doing just fine, thank you” at the present time and barring another crisis/shock/tsunami, should continue to improve over time.
And what if I am just seeing things the way I want to, you ask? Since this is ALWAYS a possibility in this business, I spend a bunch of money on independent research each year. The idea is to “farm out” the key analysis of data to people who make their livings getting these types of things right more often than not. And over the years I've learned that while nobody gets it right all the time, you should ignore or disagree with the major theme coming from some firms at your own peril.
One firm in particular has developed a nifty group of indicators it calls its Recession Probability Model. The idea is to combine the nonfarm payrolls, average manufacturing hours worked, the unemployment rate, real wages, and real salaries of each state in the U.S. and them lump them all together. The result is an indicator that has correctly called the recessions and recoveries in the U.S. on a timely basis. And since the NBER (National Bureau of Economic Research – the official keeper of U.S. recessions and expansions) doesn't ever confirm that the country is actually in or has exited a recession until well after the fact, having an indicator that can give us a clue about the state of the economy in real time is helpful.
The Recession Probability Model called the recession of 1979/1980 the very month in began. Then in mid-1981, the model's signal came one month before the actual recession started. In 1990, the signal occurred within two months of the beginning of the recession (which was triggered by the first Gulf War and as such, can be considered an event-based recession). In 2001, the indicator gave us a heads up one month into the actual recession. And finally, the model told us that the economy was sinking six months into 2008. And although this can be considered a bit late, remember that nobody knew for sure that the economy was in recession until early 2009 after the stock market had fallen more than 50%. And knowing that the U.S. was in recession in June of 2008 would have helped save investors an awful lot of money as the S&P was around 1400 when the signal was given (for the record the ultimate low of the S&P 500 during the 2008-09 bear market was around 667).
To be fair, the model was “wrong” in 2002-03 as the economy never actually re-entered a recession. But staying out of stocks based on the indicator wouldn't have been a bad idea. And then there was a very brief misfire in mid-2009 where the indicator flashed a warning for one month and then quickly retreated. But overall, the model has done a great job of managing economic/stock market risk over the last 33 years.
So, what is the indicator saying now? Although the data is only updated monthly, the probability of recession at the present time is 0.5% based on the stats from all 50 states.