Yes, the markets have been very choppy lately, and investors’ confidence may be shaky, but in his Oct. 16 Independent Market Observer blog, Brad McMillan uses the analogy of a coming blizzard to prudently remind advisors (and their clients) of why we’re invested in the markets at all.
“If we get a blizzard warning, what do we do?” asks the CIO of Commonwealth Financial Network. “Do we sell the house at a loss and move south? Or do we stock up on food and batteries, check the generator, gas up the snowblower and prepare to ride it out?”
McMillan, a CFA, then cautions that “before we make any big changes in our portfolios, let’s think about why we’re invested in stocks in the first place. We are in stocks because they benefit from a growing economy.”
In the blog, McMillan says he still believes the stock market is overvalued, and outlines why he believes we’re in a growing economy, just as he did last week in a speech at the national conference of independent BD Commonwealth in Orlando. Calling himself a “data geek,” McMillan says he relies on four leading indicators of the economy — “the ones worth watching” — whose continued “green lights” show that “things are pretty good” with the economy.
Those four indicators, which he uses to discern dark clouds on the economic horizon, are the outlook for the U.S. service sector, the private employment numbers, the yield curve and the consumer confidence index.
The Institute for Supply Management’s Nonmanufacturing Index rose in September to an eight-year high, and is at its highest level since the financial crisis, he reported, which is “consistent with business confidence.” Private employment on a year-to-year basis reached its highest levels in September, and moved up from August on a month-to-month basis.
The 10-year Treasury yield curve notched a small gain in September, but McMillan says “the spread remains at healthy levels,” though he notes that it might change when the Federal Reserve announces the end of QE3, perhaps as early as the Federal Open Market Committee meeting on Oct. 29.
As for his final preferred indicator of trouble ahead, the Conference Board’s measure of consumer confidence, it declined slightly in September, though he says “the absolute level of confidence remains healthy.” But since we haven’t achieved the higher levels of confidence seen earlier this year, McMillan gives it a green light with a warning that it bears watching.
So, he rhetorically asked his audience last week, if the economy is in such good shape, with GDP growth of 4.0% since 2010, “why is the Fed so worried?” It’s because, McMillan said, the “Fed is terrified” of repeating the interest rate decisions the then-young Fed made in the 1930s, which some observers blamed for at least exacerbating the Great Depression. (Some other observers in fact blamed the Fed for causing the Depression in the first place; for an interesting analysis of the Fed’s policy decisions in the late 1920s and 1930s, see a speech given in March 2004 by a Fed Governor named Ben Bernanke.)
However, McMillan says that he is forced by the data to say that “things are going to get better,” and highlighted four trends that will affect the economy, for good or ill.
1) Government is no longer a drag on the economy.
2) Business profit margins are so high because they haven’t invested in their companies or hiring new workers. “Business is now carrying the economy’s load,” he says, but as they put those dollars to work, “profits will suffer.”
3) Exports, while improving, won’t significantly help grow the economy.
4) Consumer spending has been down, but “this is where the money is.”
So can consumers spend more? “They need to have jobs” to spend more, so McMillan then turned to the employment numbers. Using 2004 “as a proxy for normal” employment, McMillan noted that full-time job growth is running at 3% this year, compared ithw 2.5% in 2004. Part-time job growth was at zero in 2004, and is now running at 1%. So, he concluded, “if jobs have normalized, what’s the problem” in getting consumer spending up? “Maybe it’s income? That exactly the case,” he concluded.
Income growth is running now at 3%, down from 5% in 20014 and 6.5% in 1995. “Americans have been saving and paying down debt,” McMillan said, but “that’s ending now.”
Looking ahead over the next six to 12 months, he believes “rising employment should increase wage growth.” Supported by declines in the “quit” rate, workers who have quit their jobs, in the “discouraged, not looking” rate among the unemployed and a stabilization in the number of discouraged workers who are still looking, McMillan believes that “wage growth will be slow but real.” Then, again over the next six to 12 months, “consumer spending will rise.”
However, interest rates will also rise, though he believes that “as long as they’re in the normal range,” the markets will go up.
McMillan presented one caveat to end his discussion last week in Orlando, and a timely one considering the recent market upheaval. Remember, he said, you have to “decouple the real economy” from the performance of the stock market.
Check out Commonwealth Exec Returns After ‘Brief Hiatus’ at LPL Financial on ThinkAdvisor.