What’s Next for the Economy and Markets?

crystal-ballTough question. A more relevant question would be: “How do I obtain long-term investment success?” We’ll discuss both today.

First, the economy and the markets are not correlated over the short-term. Last week’s overall market selloff again demonstrates this. Yes, over the long-run, there is a correlation between GDP growth and corporate earnings. But data demonstrates that over the short-term, there is no correlation.

Second, it is imperative to filter the noise of the media and put the current situation in broader context, than to guess about the future. Our economy is still recovering from the 2008 credit crisis. Similar crises were followed by weak GDP and job growth. The Fed confirmed last week that we are following this historical pattern. Since September 2012, when the latest QE program started, the unemployment rate has fallen from 7.8% to 7.6%. The Fed expects GDP to increase 2.3-2.6% this year. Inflation is up only 1.05% year over year.

Of course, these results, and the stock markets, have been influenced by easy money policies. Since 2008, the fed funds rate has been near zero. Hence, the Fed has employed additional policies to boost the economy. The most significant has been QE. The Economist on Friday described Chairman Bernanke’s tough assignment: “In a zero-interest rate environment, the central bank can influence monetary conditions more through words than through actions.” Mr. Bernanke’s comments last week, which pointed to the path that actions were “data dependent” were interpreted (perhaps incorrectly) by many investors to mean greater “hawkishness” (tapering was about to start). Virtually all markets tumbled.

The economic data doesn’t support a change in the bond-buying policy. Unemployment is still at 7.6%, labor participation rates are near 29 year lows, inflation expectation are falling, and perhaps, most importantly, there has been no substantial improvement in job growth:

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Yet, despite the weak pace of overall growth, the recovery in the last four years seems to be getting smoother. The housing market is up, the energy sector is booming, auto sales are improving, household finances are looking healthier and consumer confidence is at a five-year high. The Fed has increased its 2014 growth forecasts to 3% to 3.5%, from a March forecast of 2.9% to 3.4%. So, we’re making progress, but will it continue? And, if so, when will tapering start?

We agree with Yogi Berra, who said: “It’s tough to make predictions, especially about the future.” We humans are not so good with making accurate predictions. However, these days, you can generally find an opinion to confirm almost any point of view. In fact, studies have shown that the most confident, specific forecasts are a) most likely believed by readers and viewers, and b) least likely to be correct.

We prefer to focus on the long-term. People seem to lose sight of their financial future in the midst of all the noise. Most of us have a long-term investment horizon- perhaps 20, 30 years or more. During that time, we can expect bull and bear markets, volatility and short-term market swings. Emotional reactions to short-term events and media noise can cause you to miss market rallies and doom you to long-term investment failure.

You need a disciplined investment strategy and perhaps a full-time professional investment adviser to help you with it. Your asset allocation needs to represent the three asset classes; stocks, bonds and alternatives, with further diversification within each asset class. Your portfolio needs to be reviewed continually and rebalanced regularly. You need to make your capital work for you all the time, and not leave money sitting in cash. Over time, asset allocation, diversification, rebalancing and mean reversion will all work in your favor.

So, we won’t focus on predictions. Instead, what we will do is to help you establish and maintain a long-term probability-based investment approach that should reap dividends and investment success for you for years to come. Give us a call. We’d be happy to chat.

Stock Markets in an Election Year

Stock Markets in Election YearsElection years have traditionally been good for the markets. Since 1928, there have been 21 elections and the S&P index has had a negative return during an election year only three times. Of course, 2 of those 3 negative years were 2000 and 2008. Hence, there may not be a pattern and, even if there was, the pattern may not be relevant to the decisions we are about to make.

Business Week had a great series of graphs in December showing how correlation and causation are often erroneously linked. They suggest that creating statistics is easy: all you need is two graphs and a leading question to “prove” whatever you already believe. For example, did you know that babies named Ava caused the U.S. housing bubble? Well, if you graph the number of newborns that were named Ava each year starting in 1991 until now and compared that graph to a graph of the housing price index over the same time, there is a significant correlation. After 2006, Ava, for whatever reason, has become a significantly less used name for newborns. Of course, this significant decline was very close in percentage terms to the decline in the housing market at the same time. Here’s another one: did you know that Facebook is driving the Greek Debt Crisis? Again, if you graph the Facebook stock price since 2005 and compare them with the yield (interest rate) on Greek debt until now, you will find a very strong correlation. There may be a correlation, but there is certainly not causation.

In a similar way, the performance of the stock and other markets has little to do with an election year. Typically, when an incumbent is doing well in the polls it is because the economy is doing well, unemployment is low and companies are generating solid earnings. These causes drive the stock market higher and make Americans feel more secure. Conversely, when economic conditions are weak and unemployment is high, the stock markets don’t perform as well and challengers have a better chance of winning. 

Mr. Market doesn’t get into politics. He’s not a Republican or a Democrat. He’s more like radio and TV detective Sgt. Friday from Dragnet who reportedly wanted “Just the facts…” Current data and expectations concerning consumer spending, unemployment, corporate profits home and abroad, housing, inflation, world events and many other data points cause the markets to move. This information does two things- impact the markets and affect who may be elected.

Election year politics  have become a huge spectacle. Yet, Mr. Market really pays little attention to all the promises, conflicts, hype and media show. He, instead, stays focused on relevant facts and moves accordingly.