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What the U.S. Economy Signals for Stock Market

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One of the most difficult issues facing advisors today is trying to figure out the direction of the stock market. Since stocks are the most volatile asset category, they will also tend to dominate the portfolio. However, if the allocation to stocks is below some percentage, say 15%, then they may not be so dominant. But if stocks go on a bull run, this meager allocation will also hinder performance. What do we do with this dominant asset class, especially when this “domination” cuts both ways? 

If we get it right we look like champs. However, if we guess wrong, we look more like chimps (one letter leads to such a different meaning). Though I don’t believe anyone has created a tool which can consistently peg the stock market’s short-term direction, I do believe the global macro environment can provide some useful information for the intermediate and longer-term outlook. Before I proceed, there are two more issues which complicate this task. First is selecting the right data. The problem? One group of data may work one time, but fail to work another time. Secondly, stocks are somewhat manic-depressive as they tend to go to extremes on the upper and lower bounds. Ah, what’s an advisor to do? Let’s begin by taking a brief look at the situation here at home. 

The U.S. Economy

First,  American consumers have yet to open their wallets as they did prior to 2008. Moreover, the memory of the recent crash is still very fresh in their minds. Second, banks are still cautious with their lending practices, as they should be. Third, individuals do not feel confident about the economy and the direction of the country as evidenced by the recent drop in consumer sentiment

Another major factor is government debt. Government is simply a flow-through entity. Its function is to receive money from the people and appropriate it in an efficient and effective manner. When government debt increases, in essence, they are saying they need to spend more money now and will pay it back at a later date. And this need has been especially strong in recent years. In the early 1950′s, we actually had a higher debt-to-GDP ratio than exists today. However, back then, we also had strong economic growth and the ratio fell rapidly. Today, growth is anemic. In fact, PIMCO is forecasting U.S. GDP will be 0.0%. 

Therefore, unless we can get the economy growing again, when this debt does come due, it will have to be paid back through higher taxes. And that could be a strong headwind to growth as more money will be removed from the private sector, leaving less for consumption. 

Maybe we should elect a group of women to get in there and balance the checkbook? What do you think? 

Thanks for reading!