The U.S. economy is likely to post its best growth in nearly 40 years as the nation emerges from the pandemic, asserts Jim Stack, an industry leading money manager, market historian and editor of InvesTech Research.
This evidence is supported by the ISM Purchasing Manager’s survey, which shows the manufacturing sector is firing on all cylinders after climbing a robust 3.9% in March to the highest level since 1983. Strength was universally broad with 17 of 18 industries reporting growth, and none reporting contraction.
Yet while that is good news for consumers and hopefully small businesses, it is most likely not-so-good news for investors who are already battling a speculative, highly overvalued stock market.
A hot economy also opens the door to significant risks. The resurgence in demand — on top of residual pandemic disruptions — has potentially thrown an extra log on the inflation fire, as the ISM Prices Paid Index has soared to a 12-year high. This is also one of the highest levels of the past 50 years — bringing back similarities to the pricing and inflationary pressures of the 1970s.
ISM Customer Inventories is also driving these potential future inflation pressures by falling to the lowest level in its 25-year recorded history. This will undoubtedly keep pricing pressures high as companies scramble to replenish their depleted inventory and meet the unexpectedly high demand.
Meanwhile, the 8.4% jump in the ISM Service Sector survey in March was the second strongest in its 25-year history, carrying this survey to an all-time high. The Prices Paid Index for the service sector has also shot upward and is nearing a 25-year high.
So while the Federal Reserve expects any new inflation data to be temporary and transitory, we feel there is a high risk the Fed might be wrong — both on inflation, as well as their pledge to not raise interest rates until 2023.
Make no mistake about it — the current bull market remains intact. Expectations for the U.S. economy are flying high today, and investors are even more optimistic about the prospects for future stock gains.
Yet therein lies the major problem, as this is not a young bull market in terms of speculative excess, and certainly not low-risk in terms of valuation. And the “boom” headlines appearing today are an advance warning flag that should make one more nervous rather than complacent.
A critical area to closely watch in the year ahead will be Margin Debt, which measures the amount of money borrowed to purchase stocks on margin. In recent months it has soared exponentially to new all-time record highs as investors and speculators become ever more confident and even exuberant.
As the economy emerges from the COVID-19 pandemic, investors see only blue skies ahead and no clouds on the economic or monetary horizon. The Federal Reserve’s implicit guarantee of “no interest rate hikes” until 2023 is driving this speculative enthusiasm.
Unfortunately, margin debt represents leverage which can change course quickly and dynamically, and has historically exacerbated losses in a subsequent bear market. We can say with certainty that when margin debt peaks and begins falling precipitously, that a major top will be near or possibly already in place.
Our proprietary indicators are telling us to not be aggressively bullish at this time and to not bet against history. Our InvesTech Model Fund Portfolio is currently 80% invested with a defensive 20% cash reserve, and we’ve also taken steps to minimize exposure to large-cap momentum stocks.
Based on technical strength alone, there are further gains to be had in this bull market, and our strategy is to continue to pursue them without taking undue risk.
