Perhaps the essential difference between the sciences and social sciences is the introduction of human behavior. In physics and chemistry, definitive answers exist and outcomes are pre-determined. In matters of politics and economics, academia may attempt to bring a level of predictability and logic to a set of circumstances, but outcomes are never assured. This year has been one of the times where I have questioned the relevance of earning a degree in economics, as logic, history and theory have proven unhelpful, if not detrimental, in attempting to predict the course of this economic cycle. As recent events demonstrate, rational minds can look at the same set of facts and draw very different conclusions, and market participants can look at the same economic data and emerge bullish or bearish. But over the last year the facts have suggested cautious is warranted:
- The Federal Reserves has increased interest rates at an unprecedented rate.
- An inverted yield curve and historic decline with money growth.
- Leading economic indicators, such as consumer confidence and various manufacturing surveys, suggest a recession is upon us.
- A banking crisis that will impact credit availability and lending.
- A commercial real estate market that is struggling from declining occupancy, while having to refinance almost $1.4 trillion of loans (at higher rates) over the next 18 months
The Federal Reserve, after increasing interest rates for 10 straight meetings, paused in their latest June meeting. Recent inflation readings have been encouraging and without the economic pain that many thought would be required to curtail runaway prices. Unemployment remains at historically low levels, corporate profits robust, and home prices resilient in the face of a 30-year fixed mortgage that has doubled in price. \
So does that mean we have escaped what many assumed was an inevitable recession? There are several reasons why continued caution should be warranted.
- First, there is a lag between monetary policy action and its impact on the real economy. Or at least that is what my old economic textbooks would say. But common sense would support this supposition: as the cost of money increases, current investments and expenditures are completed while new projects and activities are likely curtailed as returns are diminished.
- Second, while calm appears to have returned to the regional banking sector, it is worth noting that a full six months passed between Bear Sterns collapsing and Lehman Brothers’ bankruptcy. Financial crises often take time to be fully resolved and lending tightens as banks de-risk.
- Leading economic indicators remain markedly bearish.
Commentators and strategists on CNBC are expected to have almost supernatural predictive abilities, and they rarely disappoint in expressing a level of certainty suggesting they share in such confidence. But just as the Federal Reserve erred in maintaining a easy money supply after a decade of quantitative stimulus and the recent pandemic-related spending fiscal stimulus, we too should recognize our academic qualifications do not provide all the answers. Long-term investing requires knowledge and a degree of wisdom built from experience, humility and common sense. History has shown us that it does not pay to bet against American capitalism and therein lies the importance of having a disciplined long-term strategic plan that would require one to be positive on equities, while tactical deviations are modest and cautiously expressed.
As the British author Miles Kington noted, “knowledge is knowing the tomato is a fruit. Wisdom is not putting it in a fruit salad”.