New Records, New Worries

The most hated bull market in history reached an all-time high on Tuesday as the most tepid economic recovery in memory approaches record length. These two events are reflections of each other. The markets and the economy are not the same thing, but they are interdependent. Sound economies depend on markets for capital distribution, and the performance of risk assets reflects the health of the broader economy over time.
Barring unforeseen events between now and July, the current economic expansion will become the longest the US has experienced since the post-WWII recovery. But the long duration of the expansion doesn’t necessarily mean that a recession is around the corner. On my podcast last night, guest Dr. Jay Bryson, Chief Economist from Wells Fargo, pointed out that there are fundamentally only two reasons for recessions: unexpected events, such as the Oil Crisis of 1973; and financial/asset imbalances, such as the housing bubble of 2008, the tech bubble of 2000, or the use of leverage in the equity markets in 1928-1929.
At the current time we do see some financial imbalances, such as the growth in corporate and sovereign debt in recent years. But nothing is wildly out of whack.  The imbalances can be remedied through austerity measures and/or policies that lead to better economic growth. Whether or not they are dealt with is another question (and one that I have repeatedly raised in prior Market Commentaries). But over the balance of 2019, there does not appear to be cause for an impending recession emanating from any glaring financial imbalances.
Beyond this year is anyone’s guess. Economic forecasts further out than one year should probably be taken with a grain of salt as they represent speculation more than forecasting.  That doesn’t mean speculation is pointless, or that it can’t be informed speculation, but there are simply too many variables to accurately predict the future with any degree of consistency. And there are countless potential influences in the form of policy responses and/or exogenous shocks that could dramatically change the trajectory of the economy as well.
The inability to accurately forecast the economy over the longer term has investment implications. At Farr, Miller & Washington, our approach is to build a portfolio with the intent to maintain positions over an entire business cycle or more.   After adding positions in individual securities, we continuously re-examine our investment thesis for each security. Conditions change, and so we believe our primary responsibility is to build portfolios that are resilient in the face of unforeseen changes.
Steve Weiss, a CNBC contributor who was also on my Tuesday podcast, said that market performance over the short- to intermediate-term is all about expectations.  Indeed, sentiment coming in to this year was all doom & gloom – sell your securities and buy canned goods and ammunition for barter.  (Ok, maybe not that awful, but you get the idea.) But analysts and CEOs reacted to that pessimism by resetting their guidance to include ample conservatism – an all-too common and widespread process known as “sand-bagging.” As a result of those lowered expectations, companies have, by-and-large, easily hurdled their low bars and driven stock prices higher. If expectations for performance had been ebullient, we may have faced a correction or worse on the same fundamentals! It is also important to understand that market expectations have been subdued and skeptical over most of this 10-year bull market. The slow-growth economy has informed a low-expectation market, and as a result, both have continued moving upwards, albeit slowly.
So what does this bode for the future? The widespread pessimism about the economy and corporate earnings has been the fuel behind the current market rally. And while stocks have become fully valued again, there isn’t a lot of froth (in certain areas there is some, but not in the broader indices).  A pullback in the not-too-distant future is certainly a possibility, especially if the incoming economic data deteriorate again or the Fed comes back into play. But without over-stretched valuations like we saw early last year, the technical pressures that turn pullbacks into corrections (or bears) aren’t building.
It makes most sense to stay fully invested while reducing exposure to companies and sectors that have done fantastically well and adding exposure to sectors and companies that have lagged. Efforts to time the markets by getting in and out are futile and have cost many an investor lots of money during the course of this bull market. Don’t let your emotions get the better of you!