It’s apparent that the Fed’s abrupt change in policy outlook in January has revived the party on Wall Street, suggests Jim Stack, market historian, money manager and editor of InvesTech Research.
Technical evidence is back on the bullish side, with renewed strength in both breadth and leadership. The economy also seems stable, and employment is strong.
While confidence has returned to the stock market, there are early signs of doubt emanating from the all-important consumer sector. As we have frequently noted, consumer spending accounts for two-thirds of GDP in the U.S. Thus, consumers’ confidence in the current economic situation is critical to their spending habits and the continued health of this expansion.
Historically, as the economy strengthens, the feeling of well-being carries over to the shopping public, and positive responses to surveys always reach their highest levels late in a bull market. In this cycle, however, the Consumer Confidence “Present Situation” Index in the graph below has climbed to levels not seen since the euphoric days of the late 1990s Tech Bubble.
When consumer confidence starts to waver, which it has over the past few months, it’s time to be wary. Overconfidence has typically been relieved only by a recession.
Yet the market’s ability to achieve notably stronger gains from here is more questionable. And from a safety-first strategy viewpoint, the longer-term outlook is more ominous.
The recent inversion of the yield curve is a classic warning flag — regardless of whether it remains inverted over the intermediate term. And the simmering wage inflation pressures are not going to subside anytime soon, especially when initial claims for unemployment are hitting 50 year lows.
That means the Federal Reserve might have to renege on their “no rate hike” promise before this year is over — and no one on Wall Street is anticipating that the Fed might take away the punch bowl again!
One of the most difficult aspects of negotiating the twists and turns of a late-stage bull market is keeping one’s feet objectively planted on firm ground. It’s hard to argue against positive economic reports, except with the historical knowledge that bull markets peak when economic news is rosiest.
And with consumer confidence near the highest levels of the past 50 years, one would have to think that we are approaching a peak. That inherently leaves a lot of room for potential disappointment.
Surprisingly, both small business owners and CEOs are not as enthusiastic as consumers or investors. Small business confidence fell sharply in the closing months of 2018 and has shown little propensity to recover. Corporate CEO confidence experienced an even bigger hit, and with the same inability to rebound from these depressed levels.
Business owners are most likely feeling the pressures of a tight labor market, rising wage pressures, and squeezed profit margins. That could spell trouble for earnings and business spending ahead.
Based on the late-cycle evidence in this issue, our safety-first strategy is to step softly and carry a larger cash reserve… even if that means leaving a little of the profit potential on the table.
