The steady diet of headlines pouring out of Washington has been unsettling for many Americans, regardless of where they sit on the political spectrum. Even Lloyd Blankfein, CEO of Goldman Sachs, jumped into the fray and wrote his first ever tweet criticizing President Donald Trump’s move to withdraw the U.S. from the Paris climate change agreement. One has to ask whether he is truly interested in the environment, just wants to compete with Trump, or if GS holds a lot of Twitter stock, beaten down lately.
We all know that equity markets (stocks) hate heightened uncertainty. What is happening in Washington is generating an enormous amount of political uncertainty. Even the word “impeachment” has been bandied about in conventional circles. Some pointed to that “news” to explain the one-day sell-off that caused the DOW to drop 373 points, last month.
But, political as well as international uncertainty has yet to translate into Main Street economic risk. It is here that you and I live. To assess Main Street economic risk, we look at GDP (both nominal and real), household income, consumption, and nonresidential fixed investment. The standard deviation of those elements is a measure of economic risk.
According to Dr. Woody Brock, economic risk has decreased by well over 80% during the eight decades since 1930. Indeed, there was a spike in the ’00 decade, 2000-09. But so far each of the metrics, with the exception of household income, has shown a decrease in volatility (a standard measurement of risk) this decade. The economy has improved, from a riskiness standpoint.
Many will posit that the fundamentals of the economy, extrapolated from the news, drive the market. If that were the case, one could reasonably expect that the risk of the market would have also declined by more than 80% over those same decades. That simply hasn’t been the case. In that same period there has been only a 20% decline in market volatility (a standard measurement of risk).
Much will be said about the economy improving and that will likely be given as the reason for this or that happening in the market. In reality, it is very difficult for anyone, including professionals, to make correct investment calls based on the news. That’s because mistakes in interpreting the news are rampant.
Remember when nearly everyone believed that house prices almost always go up and almost never drop. Furthermore, the price paid for a house didn’t really matter. That led to overshoot of the price and the ultimate bursting of the bubble. We all now know that that belief, so widely held by investors, was a mistake. The news, in my opinion, represents mere noise. Today, we must concern ourselves with the prevailing stories that may turn out to be wrong.
So what should we be concerned about today? A possible list includes:
- Excessive debt levels. Margin debt is at a record high and student loan debt now exceeds other forms of debt.
- Increasing levels of pricing model uncertainty. Discerning the true value of an investment today is quite different than it was a few years ago before the advent of today’s large, hi-tech companies.
Despite the frequent distractions from the popular press, we are keeping a firm eye on the market fundamentals, as well as the technical signals to navigate through these uncertain times. You might want to turn off the TV and enjoy your weekend and summer.
June 2, 2017