The Stock Market is Overtaking the Economy

Recession talk has been grabbing the headlines since last week when the yield differential between 10-year notes and 2-year notes inverted. This news spooked equity investors because yield inversions historically have been reliable harbingers of US economic recessions. Adding this to the stalemated trade talks between Washington and Beijing triggered investors ready to wave a white flag on the economy. The White House trotted out its economic boosters, Peter Navarro and Larry Kudlow, to appear on the Sunday news shows to prop up animal spirits. It wasn’t just theatre, though, as the points they raised are valid.

We agree with them that the likelihood of an imminent US recession is low. Consumer spending accounts for two-thirds of US economic growth, and the American consumer is in good shape. The labor market is on fire: according to the Bureau of Labor Statistics, there are currently more job openings than there are unemployed workers. Consumer confidence is at levels not seen in 20 years.

Yes, there are concerns, and we closely monitor the indicators. Business investment dragged down last quarter’s annualized growth rate by 1 per cent, as firms assess the shifting sands of trade. New orders minus inventories, a useful coincident indicator of production, has fallen precipitously in recent months and is flirting with contraction territory. The future direction of US economic growth will continue to be debatable.

But as detailed above, Cresset does not see recession in our immediate future. Investors should bear in mind that a recession will come, at some point, as part of the natural longer-term economic cycle. But we think this is unlikely before mid-2020. We are more concerned right now about the equity market than about the economy. The value of US stocks relative to GDP is at levels not seen since 1999 and suggests the market has become untethered from the economy. Low global interest rates, unprecedented quantitative easing and vast liquidity are part of the story. But given the outsized relationship of stocks relative to GDP even economic slowing, not necessarily a recession, could create headwinds for the equity markets.