Goldilocks vs the Bear: The Bear Wins

The environment that the Federal Reserve envisions for the economy won't be friendly for stocks.

The Wall Street Journal reports (and I agree), Even a Goldilocks Economy Could Be a Bear for Stocks.

> On balance, policy makers expect to raise rates four more times by the end of next year. The economy will slow, with gross domestic product up 2.5% on the year in the fourth quarter of 2019. The unemployment rate will drift a bit lower to 3.5% and inflation will come in at 2%.

> What is the outlook for companies under that scenario? If their demand grows about as fast as the economy, adding in inflation, sales would be up about 4.5% in the fourth quarter next year. So the only way for profits to grow at a faster clip would be for profit margins to expand.

> That seems like a bad bet. Even after adjusting for the effects of this year’s tax cut, profit margins for companies in the S&P 500 are historically quite high. Then consider how hard it would be to contain, much less cut, labor costs with an unemployment rate at 3.5%.

Bad Bet

Image from Five plot holes often overlooked in the story of Goldilocks and the Three Bears.

The WSJ article puts things mildly.

It's not a "bad bet" to think profit margins will expand. It's a "horrible bet".

Eight Reasons Financial Crisis is Coming

I note Eight Reasons a Financial Crisis is Coming

Yes, that is looking at things quite pessimistically. Yet, even the alleged Goldilocks scenario is unlikely to keep stocks on track.

Anything worse spells serious trouble. Any of eight things will suffice. I expect all eight.

And if Goldilocks appears?

Most likely, you still lose, for seven straight years.

Click on the above link for further discussion.

Mike "Mish" Shedlock

Comments (15)
No. 1-7
2banana
2banana

To summarize:

There is no more road to kick the can down....

"Buy gold. A financial crisis, not just a recession, is on the horizon."

CautiousObserver
CautiousObserver

Regarding the five plot holes in Goldilocks and the Three Bears, I may have some explanations that leave the author's assertions of fatal flaws in the story in doubt:

Assertion #1: Bears do not have enough income to get a mortgage.

Explanation: At one time banks were lending money for home mortgages to anyone who could fog a mirror. Bears can fog a mirror, so they qualified.

Assertion #2: Nobody goes for a walk while their food cools down.

Explanation: Bears do. They prefer their food to be somewhat cool because they are prone to chomping and gulping.

Assertion #3: Bears do not eat porridge.

Explanation: Bears eat what they can get.

Assertion #4: The bear parents sleeping in separate beds is evidence their marriage was in trouble.

Explanation: Bears have big claws and teeth. They are prone to injuring each other if they sleep too closely.

Assertion #5: The break-in was clearly staged. Goldilocks is a patsy.

Explanation: Like many children her age, Goldilocks was curious and did not spend much time concerning herself with the longer term consequences of her actions. She did not "break-in" per-se. More precisely, she wandered in and started investigating. Being bears, the bear family felt there was little reason to lock the doors and windows before they went for their short walk. If anything wandered in while they were away, they figured they would eat it.

Casual_Observer
Casual_Observer

Rising rates will expose how this boom was created - the lowest interest rates we have ever seen financed a corporate finance boom like the boom we saw in low regulations and interest rates in the 2000s. Credit lines will soon be pulled as profit margins shrink. Japan and others also will be spooked by higher rates as per John Mauldin this week.

Thanks to the “exorbitant privilege” I discussed earlier this month, the US has long had many foreigners willing to buy our debt. Now they are losing interest (forgive the pun) because hedging their currency exposure costs more. There are some complex reasons behind this, relating to swaps and the differentials between the US economy and others, but here’s the bottom line: European and Japanese investors can no longer buy US Treasury debt at a positive rate of return unless they want to take currency risk, which most do not. This is a new development.

Kinuachdrach
Kinuachdrach

It is hardly controversial to note that the financial economy and the real economy parted company some years ago. The financial economy performed well, while the real economy stagnated. Interesting! And almost certainly a result of the Federal Reserve's actions, along with the burden of excessive regulation on real productive activities.

Could there be a scenario in which the reverse happens? The financial economy takes a hit as reversion-to-mean occurs, while the real economy does ok. The guys who hold stocks & bonds lose paper wealth, while the working stiffs who actually produce real goods & services continue to earn their income and live their lives.

In this scenario, financial losses would likely be limited by holding shares in unsexy companies which make boring essentials and pay dividends -- toilet paper, electricity, food, etc.

Realist
Realist

Mish has been calling for the next recession and market crash for years. Of course, eventually he will be correct. In the meantime, the US economy has been growing slowly and steadily for 9 years. As a result the economy is actually in pretty good shape. In fact, Millions of jobs sit empty due to a lack of skilled workers. Tax cuts gave the economy a small boost this year but are now being offset by Tariffs. Interest rates are going up slowly and appropriately. However, if Trump expands his Tariff wars, the negative effects on the US economy will reduce the need for interest rates to keep going up. I don’t see a recession in the next year or two, barring some black swan event.

Casual_Observer
Casual_Observer

The reason those jobs sit empty is because they arent legitimate jobs that will produce growth. Companies are a lot more cautious than previous booms because theyve used the corporate bond market more than they care to share. There is a house of cards in the corporate bond market that mirrors the RMBS market harkening back to the 2000s. Shortage of skilled labor is no longer an issue. Our economy is still built on the FIRE economy. We will soon see how heavily we are dependent on low interest rates that financed this boom. The excesses of the last boom never ended.

Realist
Realist

”the jobs that sit empty aren’t legitimate jobs that will produce growth” That is a very interesting way of looking at things. Employers that I deal with are looking for all kinds of ”legitimate” skilled workers: tool and die, construction, electricians, electrical engineers, hvac, plumbers, truck drivers, chemists, software developers, botanists, stone masons, mechanics, mechanical engineers, and on and on. If you have any skill at all, you should be working. The jobs sit empty because there are not enough skilled workers, not because employers have suddenly decided to post imaginary jobs just for fun. On a macro level, looking forward I see growth continuing to slow, eventually to 1% real growth. The next few decades will see stagflation; low real growth with higher inflation. Interest rates will be modestly higher, which will be one of the reasons for slower growth.