Commonwealth Financial’s McMillan Still Sees 4 Economic Green Lights

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.