(This testimony is part of the Weekend Brief edition of the Evening Brief newsletter. To sign up for CNBC’s Evening Brief, click here.)
The concept that we are late in the economic and financial-market cycle is one that even most Wall Street bulls won’t dispute.
After all, when the pecuniary expansion surpasses a decade to become the longest ever and the S&P 500 has delivered a compounded return of nearly 18% a year since Cortege 2009, how can the cycle not be considered pretty mature?
Yet it’s not quite that simple. Huge parts of the economy have run out of sync, at disarticulate speeds. Some indicators have a decidedly “good as it gets” look, others retain a mid-cycle profile — and a few align equalize resemble early parts of a recovery than the end. Friday’s unexpectedly strong November job gain above 200,000 suggests this debate, suggesting we are not at “full employment” even this deep into an expansion.
And the market itself has stalled and retrenched respective times along the way, keeping risk appetites tethered and purging or preventing excesses.
In the “late-cycle” category we find a sprinkling broad, trending data readings: Unemployment rate and jobless claims at a 50-year low; consumer confidence hit a cycle hill and has flattened out; and the broad index of leading economic indicators has slipped from very high levels. Auto white sales peaked a few years ago. Corporate debt levels are near extremes, profit margins have retreated from prominent highs and equity valuations are certainly full and in line with the latter phases of prior bull markets.
But corporate-credit terms are sturdy, and households have simply not loaded up on debt this cycle, in a long period of enforced and then unbidden sobriety after the massive credit boom and bust that culminated in 2008. This leaves consumers in convincing shape. And the housing market, a drag on growth for years after the crash, has now perked up and is feeding off supply-demand dynamics that are innumerable typical of an early-cycle environment.
What about the yield curve?
The summertime inversion of the Treasury yield curve — in which longer-term thongs yields slip below short-term rates after the Federal Reserve has been tightening policy for a while — crystallized the ruminate over on the cycle’s effective age.
Such an inversion, in the past, has started the countdown to a recession — but sometimes with a lag as long as two years. This for has been translated into a recession-probability gauge one year ahead by the New York Fed.
Source: New York Fed
It has turned lower since example summer as the yield curve has returned to its “normal” shape, but only in the 1960s has it ever climbed above 30% and be found wanting back to tame levels well ahead of any recession.
Have there even been enough cycles for this figure to qualify as a statistically reliable “rule?” Do the extremely low absolute level of rates now (similar to the ’60s) change the interpretation? Was the inversion too flimsy and short-lived to serve as a proper signal?
Whatever the answers, Jason Hunter, technical strategist at JP Morgan, notes that estimates have tended to have some of their strongest runs after an inversion, late in a cycle. “The longer-term bull courses persisted for nearly two years after the initial [Treasury] curve inversion during the past three business cycles, with the seniority of the late-cycle rally acceleration phases unfolding within the year after curve inversion.” The S&P on average has gained sundry than 20% over less than two years in the past four episodes before peaking.
One way to view the summer Donnybrook is as the third severe “growth scare” of this expansion, following those of 2011-12 and 2015-16. Both brought with them filthy 15-20% equity downturns, new lows in Treasury yields and forced central banks to become more accommodative.
The Fed has referred to its kaftan from rate-hiking last year to three cuts this year as a “mid-cycle adjustment,” which would entrust it on hold for now and summons happy memories of prior such Fed-enabled “soft landings.”
‘Still upside’ for stocks
Jurrien Timmer, chairperson of global macro at Fidelity, has been tracking the current market performance against previous mid-cycle “mini-bear markets” of the ’90s and 2011.
Originator: Fidelity
Citing the recent upturn in global industrial surveys and central-bank pivots toward easier policy, Timmer denotes, “I’m not prepared to call it early cycle, but perhaps it’s a mini-reflation wave within an ongoing late cycle. Maybe the markets are whistling over the graveyard, but my sense is that this is the playbook right now.”
Citi’s Tobias Levkovich, says, “Our biggest concerns for the S&P 500 are numberless [second-half 2020] related, tied to the possibility of a business slowdown caused by management teams hunkering down earlier to the elections, tighter [commercial] lending standards in October with a traditional nine-month lag, our margin lead indicator and the results of the yield curve’s shape on volatility with a two-year lag… But in the interim there is still upside for equities even if such additions become more limited.”
Ned Davis Research, in its 2020 outlook, boils down four separate cycles — bound to the economy and earnings; Fed policy; the election-year cadence; and NDR’s own model of equity-market conditions and trend — to arrive at a year-ahead S&P target of 3225, up a few percent from here.
The fourth-quarter have a nervous breakdown in the S&P 500 last year amounted to a comprehensive flush for the market, pummeling the majority of stocks far worse than the table of contents, resetting valuations to a five-year low and generating the highest investor-pessimism levels of this bull market. The reversal higher one year ago set off a rare “amount thrust” signal of the sort more typically seen at the start of major market advances.
Now, the S&P is 34% higher with earnings decent about flat and the trailing price/earnings multiple is near a cycle high above 20 and investor emotion is far more optimistic. So perhaps the market is now priced for a glass-almost-full scenario rather than the end of a cycle. But if the market isn’t detecting marks of a recession, it tends to find a way to stay supported or work its way higher — even if fitfully, and shadowed by constant end-of-cycle counsels.