INSIGHTS

On April 17, 2017

AAM Viewpoints – The Most Promising Words Ever Written

“The most promising words ever written on the map of human knowledge are terra incognito – unknown territory.” – Daniel J. Boorstin | The Discoverers

The series of books written by Daniel J. Boorstin encompassing The Discoverers, The Creators and The Seekers (to name a few) are consistently at the front of my library and re-read time and time again. As I pulled my favorite of the bunch, the quote above resonated with the message of uncharted territory that we are being bombarded by today.

We are inundated with the notion that we are in uncharted territory from all mediums, from both professionals and lay folk. This doesn’t just reside in the economic front or capital market arena, but politically and culturally as well. As most are only topically informed in these areas, it is easy to fall for the salesmanship of recalling an arcane moment in time to persuade an individual into agreement. It is the opposite of the illusory superiority bias that we most often fall victim to – the bias where we overestimate our own strengths. In such a complexity of acts and occurrences, we often can’t cognitively put the pieces together as we saw in A Beautiful Mind in which Professor John Nash worked the connecting pieces on a window or via strings on a cork board.

So as we battle the data showing higher margin debt, equity markets at all-time highs, potential for a Euro disbanding via elections in France, geopolitical tensions always at “DEFCON 1” and incessant crib fights arising from Washington, there is some solace in looking at some hard economic, corporate and household data. This can help potentially affirm or deny the emotional component we all battle in determining where and if we should invest. Spoiler alert, we believe the answer to the last question is always yes; it just varies in where you invest.

• Global Purchasing Managers Index is still running at very significant levels; the JP Morgan Manufacturing Global PMI is running at 53.0 with their services PMI component is at 53.6. Accordingly, that would project Global Real GDP at 3.2%.


• Consequently, the Global Earnings is seeing upgrades in the first quarter for the first time in six years. Earnings estimates have started out higher and then been consistently revised downward since 2012.


• Though a smaller component of Domestic GDP, the trailing three-month average of the change in U.S. exports has seen tremendous acceleration in the last year. Especially significant is the change in the last few months that has now seen U.S. manufacturing exports rise into positive territory for the first time since 2014. This is in light of a recent rally in the dollar that normally puts pressure on manufacturing exports.


• Shifting winds in the corporate pension market from Bloomberg’s article, U.S. Pensions on Verge of Corporate-Bond Shopping Spree. They state that now corporate pensions on average have 82% of the funding needed, up from around 75% in the middle of last year. This typically shifts purchasing of debt to lock in these levels and move away from riskier assets. According to Morgan Stanley, the estimate could be a big influence on the long end of higher quality bonds. I would argue that with convexity being a significant issue from coupon being at historic lows on this debt that lower risk may not correlate with this move. Higher interest rates and inflation can seriously erode returns should expectations on each of these be exceeded.


• Consumer and small business sentiment continue to be in very positive territory. The University of Michigan consumer sentiment is at high positive levels that has occurred less than 10% of the time since 1978. The conference board consumer confidence number is tracking the same with the University of Michigan number in its being in such rare levels of positivity. The NFIB small business optimism index is at levels that have only occurred 5% of the time since 1977.


• The Leading Economic Index (LEI) year over year has now exceeded its long-term average. Since 1960, the average has been 2.4 and the current reading is 3.1. The LEI takes 10 various indicators comprised from economic and capital market measures to calculate the overall environment for the U.S. economy.

One side note on the leading economic index is the way the yield curve often reacts. Historically when the index would break above a long-term average, the curve steepens. We measure the curve in this scenario as the 30-Year U.S. Treasury minus the 3-month U.S. Treasury T-Bill. There are various other spreads we look at for different reasons, however, in this measure the curve depth usually got steeper. Recently it compressed, though we think this is temporary. The economy is accelerating domestically so a recession looks far off in the distance, in our opinion, and this would be traditionally corroborated with an extremely flat curve, if not inverted. The average spread in the last 40 years has been 208 bps (basis points), or right where it is at currently.

As emotions continue to run high, so too does the economic data. Our natural reaction to perceived unchartered territory is to be pragmatic, and that is exactly what the majority of prognosticators are forecasting. We also find several calling for calamitous results. The one forecast that has the fewest calls is for higher-than-average risk asset returns. With the benefit of hindsight, it is our experience that those projections with the least backers occur more often than one would think and with extraordinary results.

CRN: 2017-0403-5883 R

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.