It’s Not Time To Panic (Yet)

So, the market’s finally gotten a little interesting. It’s been a while. I feel like we’ve been sleepwalking through years of stable and steady market returns. In fact, the last few years have been unusually stable. The 3 year rolling standard deviation of a 60/40 stock/bond portfolio has been just 6.2 since 2010. The average since 1930 is 11.1. So, we’ve been spoiled by high and stable returns in the post-crisis period and now it looks like the party is ending. But does that mean we should panic and destroy the evidence before mom and dad come home? Let’s think this through before we overreact.

The 30,000 Foot View

My basic macro view is simple – I think the US economy is doing okay. We’re still muddling along, but there are no huge red flags out there. There are pockets of housing that are bubbly, but it’s nothing close to 2006. And the banking system is much healthier. So some correction in places like San Francisco, Seattle, Austin and other booming cities could be a welcome development. Of course, if you subscribe to the theory that housing is the economy then this will have at least some meaningful impact on GDP. It could even be enough to drag us into a minor recession. But the macro risks in real estate are nothing like they were before the GFC so let’s not blow this out of proportion.

As for other segments of the economy – there’s legitimate worry about some excesses in the tech sector and the growth in corporate debt. The energy sector is clearly sluggish as oil prices crater. But this looks more foreign demand driven than domestic. So there’s pockets of risk in the US economy, but nothing that looks to me like a widespread macro risk like the way things looked running up to the GFC.

The foreign picture is less certain. Europe is, well, Europe with their half constructed monetary union and Brexiteers. And China is, well, who the hell knows. And that’s actually a legitimate worry. I am waiting for the day when China sneezes and the world catches a cold. And since the Chinese economy is so opaque there’s a real worry that something could be happening over there that catches us off guard. Still, the US is somewhat insulated from recessions in China, but a GFC style event in China would certainly reverberate around the world. And I won’t even begin to pretend to know whether that’s happening right now or not.

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