Opinion: The economy is in much better shape than the headlines say
Inflation is through the roof.
There is an oil crisis. A looming food crisis. You name it.
War is raging in Europe.
The Russian president is starting to look unhinged. And the headlines now link it to chemical weapons and nuclear weapons.
Ohmyhgaad – Ohmyhgaad – Ohmyhgaad!
Things are so bad that stories that would normally make headlines – like the waves of Covid cases and deaths, China locking down cities and North Korea firing long-range missiles – barely deserve a mention.
No wonder stocks have fallen this year.
US consumer confidence figures are at their lowest only during the global financial crisis and crises of the 1970s. Indicators such as the American Association of Individual Investors’ weekly sentiment survey and the CNN Fear Index & Greed, show that investors are at extreme levels of misery.
If you’re tempted to cash out your IRA and 401(k) stock funds and hide under your desk, you’re not alone.
But before you do… listen to Jim Paulsen.
He is the chief investment strategist at Midwest fund management company Leuthold Group. And he recently gave a presentation to clients who might have been called…with my apologies to the late Ian Dury—“reasons to be joyful”.
In a nutshell, Paulsen says: Things aren’t as bad as you think. He thinks the economy is in much better shape than the headlines say. The stock market will go up, sooner rather than later. Oh, yes, and that there are good profit opportunities for any individual investor.
Take it or leave it, but Leuthold is not your usual Wall Street sportsbook. The Midwestern firm is a pretty skeptical, down-to-earth place. He even runs a “Grizzly Short Fund”, which bets on falling stock prices. They’re usually not stupid cheerleaders.
What about Paulsen? Here are his top 3 reasons to look on the bright side.
The big news of the moment, largely forgotten in the current panic of Eastern European news, is that the pandemic is over. Policy makers, and even the media, have finally come to accept that Covid is not going away but will have to be managed: it will be “endemic”, instead of a pandemic. Net result: The world reopens. Businesses are restarting. People will travel. They go shopping. They are going out to the restaurant.
Oh, and most importantly, stores are going to have to restock their empty shelves, after two years of a supply chain crisis. Inventories are at historic lows relative to gross domestic product, he points out. Corporate order books are near 30-year highs. Plus, he adds, consumers are sitting on about $1.5 trillion in additional savings because they’ve spent less money over the past two years.
While the Atlanta Federal Reserve’s real-time GDP tracker shows a slump in first-quarter growth, Paulsen points out that the Citi US Economic Surprise Index is up. And he has a leadership record where GDP follows. Meanwhile, corporate earnings look extremely healthy and estimates have been revised upwards since the start of the year.
As for the humanitarian catastrophe unfolding in Ukraine due to the Russian invasion, the actual effects on the US economy are likely to be less than the headlines suggest, and temporary, Paulsen argues. And it’s true whether the war ends soon (hopefully) or turns into a protracted stalemate.
Works! Works! Works!
The US economy created 1.2 million new jobs in the first two months of this year alone – a stunning achievement, and achieved despite the lingering drag of the Omicron Covid outbreak. There is still plenty of room to grow. We are still more than 2 million jobs below the pre-Covid peak, and Paulsen notes that after every recession since World War II, the labor market has reached new highs, often well above the previous peak.
Figures from the US Department of Labor suggest the economy could generate an additional 7 million jobs just to get back in line with the growth trend seen just before the pandemic. Paulsen points out that the unemployment rate has fallen in the 44 states with the smallest economies, but not yet in the “Big Six” which actually contain the most jobs, namely California, New York, Texas, India. Illinois, Florida and Pennsylvania.
Meanwhile, wages are skyrocketing. The Atlanta Federal Reserve’s proprietary “wage tracker” shows annual wage inflation skyrocketing to 5.8%, higher than at any time since at least the 1990s. But as As Paulsen points out, most of this wage growth is for the lowest-skilled, lowest-paid people, who are finally getting (slightly) better wages. So we’re hiring millions more workers and they have a lot more money to spend, especially those who are most likely to spend.
This brings us to the cliché of 800 pounds in the room, namely inflation. This is the current source of panic, and there is much talk of “stagflation” in the style of the 1970s. The official inflation rate hit an abysmal 7.9% in February, the highest in decades. Federal Reserve Chairman Jerome Powell is officially alarmed and has stopped saying it’s “transitional.” Paulsen says that’s probably the biggest risk right now. If the Fed doesn’t bring inflation down, he says, the recovery will end fairly quickly.
But…well, as Paulsen puts it, “inflationary hysteria is everywhere, except in the financial markets”. Despite all the panicky headlines, the bond market isn’t worried about inflation. Neither the stock market nor the foreign exchange markets.
In the 1970s, for example, when inflation hit 6%, the bond market reacted by demanding an 8% yield on 10-year US Treasuries, to reflect risk. Today, that return is not even 2.5%. In the 1970s, soaring inflation caused stocks to crash. This time around there has been a correction, but so far it is reasonably modest. Oh, and in the 1970s, soaring inflation caused the US dollar to plummet in the currency markets. This time the dollar is rising.
The Atlanta Fed says current inflation is primarily in highly flexible priced products, such as cars, fuel, clothing and food. These prices can fall as quickly as they rise. The rate of inflation among “sticky” items like rent or medical care, where prices tend to stay flat once they’ve risen, is just 4%, he says. Meanwhile, the San Francisco Fed calculates that most of the current inflation is due to reopening and supply chain issues following the two-year crisis.
The main measure of inflation to watch is the so-called five-year “equilibrium rate” of US bonds, a technical measure that is actually the bond market’s own five-year inflation forecast. And it’s going up — it’s been going up for over a year — but it’s still 3.57%, less than half the current rate of inflation. In other words, the bond market is still predicting that inflation will halve from these levels, and quite quickly. If you know something the bond market doesn’t, get out there and get rich.
Reasons to be bullish? Maybe, maybe not. But since sentiment is already close to peak gloom, logic suggests that the next move is more likely to be up than down.