Twenty-six hundred years before Cher, Bono, or Madonna, Aesop was the “one name” big shot. This guy accomplished a lot in his thirty-six years on this Earth; his fables are still a rite of passage for many children.
None capture the modern environment of financial media better than “The Boy Who Cried Wolf.”
Financial media, from mainstream news sources to blogs and newsletters, are full of people always calling for a financial market crash. These folks wear tinfoil hats and secretly wish the Illuminati would make a comeback. We refer to them around the office collectively as Dr. Doom.
You know who I’m talking about: the people who cry “crash” every week for ten years until it finally happens.
Right now, Dr. Doom is on every street corner crying for U.S. equities to crash.
These folks are compensated based on clicks rather than portfolio performance, and unfortunately for them, economic and financial market data is revealing them to be nothing more than the boy who cried wolf.
Causation versus Correlation
One of these clickbait guys’ favorite moves is to pick one factor present in previous recessions and parade it in front of you as evidence that another recession is just around the corner.
I’m not going to geek out, but these people either don’t understand or willfully ignore the difference between causality and correlation.
Right now, the tinfoil hat crowd is crying “crash” while waving a chart of the U.S. 5-year to 10-year yield curve in our faces.
The difference between the 5-year Treasury yield and the 30-year yield is currently 90 basis points. It just so happens that during the last two recessions, this yield curve “flattened” to this exact level.
Dr. Doom is pointing to this one factor as proof the U.S. is on the verge of entering another recession and causing a stock market crash in the process.
Folks, you don’t need a PhD in economics to know that the world is a complex place. Anytime there is a recession there are a number of factors that contribute, not just one.
No one, not even Nostradamus, can look at a single factor and predict the next economic recession.
From a data-dependent perspective, there is very little risk of a U.S. recession over the next nine months. Period. These guys are going to have to figure out another reason to cry “crash” for at least nine months before the possibility of a U.S. recession begins to rise at all.
Super Bowl Cries What?
Pointing to one factor and saying it’s the “be all and end all” for determining economic recession risk is like using the Super Bowl to determine the future direction of the stock market.
Back in the 1970s, Leonard Koppett figured out that the Super Bowl winner could accurately predict the future direction of the S&P 500. If the AFC team won, the S&P would lose ground over the next 12 months, but if the NFC team won, then the S&P would gain in the following year.
At the time Koppett discovered this “connection,” the Super Bowl had accurately predicted the S&P direction 100% of the time. As of last year, this predictor of S&P returns has been right 40 out of 50 years — an 80% success rate!
Clearly, the Super Bowl has no predictive power for determining the direction of the S&P 500; this is just a coincidence. In a similar way, any single factor that was present during past economic recessions has no predictive power for determining the likelihood of the next one.
Data Dependent Cries What?
U.S. equity markets don’t crash, meaning a peak-to-trough drawdown of 20% or more, outside of economic recessions. And for the U.S. stock market to even experience a “correction,” which is a peak-to-trough drawdown of 10%, you need an environment of slowing growth. Based on current economic and financial market data, neither a correction nor a crash are in the cards anytime soon.
In recent weeks, we’ve had strings of economic data pointing to further improvement in the U.S. economy. The annual growth rate in durable goods orders has now accelerated for eight straight months, and industrial production growth is also in an upswing. Not only that, but the latest report on money being spent for capital expenditures also shows growth accelerating month after month.
However, it’s not just macro data confirming economic strength.
With just over a third of S&P 500 and Nasdaq companies having reported earnings, we are seeing both sales and earnings growth accelerating since this time last year.
Sales growth is registering an annual clip of 4.7% for the S&P and 10.4% for Nasdaq companies. On the earnings front, S&P companies are growing at 6.8% and Nasdaq at a whopping 36.7%.
If you’re a skeptic who thinks companies use accounting gimmicks to juice their growth rates, maybe you’ll listen to what markets are saying in real time.
My High Growth Index (made up of assets that outperform when U.S. growth is accelerating) is outperforming my Slow Growth Index (made up of assets that outperform when U.S. growth is slowing) by 570 basis points this year.
More importantly, 172 basis points of that outperformance was earned during the first four weeks of Q4. Financial markets are telling us in real time that the U.S. economy is continuing to accelerate here in October.
Economic, corporate and financial market data are all congruently bullish, which may have something to do with the fact that both the S&P and Nasdaq 100 have clipped a fresh set of new all-time highs in just the last 8 trading days.
The Bottom Line
I know it can be hard to stay at home when you hear the boy on the hillside yelling “Wolf! Wolf! The Wolf is chasing the sheep!"
The problem is that there are only two scenarios for investors who run up the hill every time Dr. Doom cries “crash”.
Best case scenario, these investors live in a constant state of fear that the next market-related wolf is just around the corner. This fear causes them to miss opportunities to grow their wealth, or to preserve it by outpacing inflation.
Worst case, these investors bet against markets prematurely, believing this time there really is a wolf. Unfortunately, they find out the hard way that once again no wolf exists and the only thing they’ve accomplished is raising the “cat food and greeting” risk of their portfolio.
Take it from me: when Dr. Doom cries “crash,” don’t run up the hillside. Just stay home. And most importantly, stay data dependent, process driven and risk conscious.