Even bulls have been challenged to keep pace with the markets. A strategist keenly wired into the current bull market, even Orlando has found himself racing to keep up this year. In the first quarter, his target was for the S&P to hit 2,500 by December 2017, and 3,000 by 2000. Now he expects the index to reach 3,000 by year-end and 3,200 by the middle of 2019. Most other strategists are slightly more cautious for 2018, with most projecting high single-digit advances.
At that point, however, Orlando and his team may start looking for potential signs of a recession. A downturn in 2019 remains unlikely in Orlando’s view, but by 2020 or 2021 it’s not out of the question.
Things can change very fast, DoubleLine CEO Jeffrey Gundlach told advisors at the annual Schwab Impact conference in Chicago in November. In late 2017, the leading U.S. economic indicators were flashing green lights. Most foreign stock markets are beating America’s, and Gundlach noted many measures of economic growth are stronger in Europe, where the European Central Bank is still engaged in quantitative easing.
Jim Swanson, chief investment strategist at MFS, already is seeing signs that the cycle is winding down. These include levels of margin debt to GDP and the number of hours worked it takes to buy one unit of the S&P 500. Both are at or near record highs.
Another metric Swanson cites is companies’ free-cash-flow yield, which has averaged 5.2% of their market capitalization in the current cycle. Over the long term, that figure is 2.6%. Yet as the market moves relentlessly higher, it is now down to 2.4%, or less than half of what it was at the cycle midpoint.
For the Goldilocks’ virtuous circle to continue, everything needs to continue to go right. Swanson worries that profit growth will slow next year as the Fed keeps raising rates. Unlike workers in China, where wages have climbed 300% in the last decade, American workers have experienced only small income gains.
The upshot is that U.S. consumers don’t “have the firepower” to keep an expansion going. That’s why Swanson is looking for a mild recession in mid-2019.
David Rosenberg, the chief economist with Gluskin Sheff, goes further, saying the next recession could begin in late 2018. After a full year of Trump-mania in U.S. equities, “the pace of real final domestic sales, at 2%, is the same as it has been all cycle,” he wrote to clients in early December. “Animal spirits and hopes over tax reform have not changed this trend line of subpar activity.”
GDP growth is based on only two variables—population growth and productivity—and both statistics have fallen short of their historical averages for more than a decade. Former Fed Chairman Alan Greenspan has called productivity stagnation the biggest mystery of 21st century economics.
Whatever the reason, productivity expanded at a faster-than-average rate in the second or third quarter. Orlando thinks the Trump administration’s stress on deregulation may help explain the trend. Rosenberg believes automation and robotics, coupled with the advent of the shared economy, may have been understating actual rates of worker efficiency for some time.