EC Monthly Macro Monitor – August 2020

One of the advantages we enjoy here at Alhambra is the opportunity to interact with a lot of investors. We talk to hundreds of individual investors on a monthly basis, giving us a front-row seat to everyone’s fear and greed. Economic data tells us about the past, which isn’t particularly useful for investors focused on the future. Sentiment, though, is what moves markets and markets are what shape the future economy. If you’re looking at economic data to try and figure out what the market will do, you’re doing it backward. You should instead look to markets to figure out what the economy will do.

The most common comment I’ve heard over the last couple of months is: “The stock market makes no sense. Why are stocks soaring when the economy is so bad?” Well, I’ve got news for you. The stock market rarely makes sense if you compare it to the economy of right now. The correlation between current economic growth and stock market returns is basically nil. One study from three professors at the London Business School (Dimson, Marsh & Staunton) looked at 19 different countries with data back to 1900 and found a negative correlation between GDP growth and stock returns. Other studies have shown only a slightly positive correlation.

So, if you are wondering why stocks are “disconnected” from the real economy it’s because that’s their normal state. Stocks, like all markets, look ahead, although one might wonder sometimes if what stock investors see is more mirage than reality. Someone once described the stock market to me as like a chihuahua on the end of a leash and the bond market as like a bulldog. The chihuahua is out at the end of the leash straining this way and that, yapping at everything that crosses its path, running back to your side when it gets scared. The bulldog sticks to your side and wonders what all the fuss is about.

There’s an old Wall Street saying that the stock market has predicted 9 of the last 5 recessions and it exists for good reason. No market is infallible and you know that well if you experienced the dot com or housing bubbles. And of all markets, stocks may be the worst of the lot when it comes to economic forecasting. Not even the stodgy old bond market gets it right every time although the yield curve is batting 1.000 over the last few decades.

Markets don’t always agree about the future direction of the economy because each market is dominated by different traders and investors. Commodity traders may interpret things differently than stock or bond traders. In addition, there can be factors unique to one market that don’t translate to others. Commodities might fall before a growth slowdown shows up in earnings and affects stock prices. Gold might rise before the dollar falls. That’s why you need to look across multiple markets to try and get an idea of what to expect – or more accurately what everyone else expects. The wisdom of crowds works better when you have a bigger, more diverse crowd.

Another thing I hear a lot these days is that the recovery to date was artificially induced by government stimulus. The $1200 checks and the enhanced unemployment benefits are the only things that supported the economy over the last few months and if Congress fails to pass another stimulus the economy is bound to fall right back in the hole from which it just emerged. Even those who believe a deal will get done think it is only temporary and when the “stimulus” inevitably ends – we can’t keep paying out trillions we don’t have, can we? – the economy will relapse.

I suppose there is some truth to that but probably not to the degree many assume. One-time stimulus payments are hardly new and we know what happened when they were tried in the past – they were largely saved. And guess what? That’s exactly what happened this time around too.

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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