In my last blog post I wrote about Howard Marks’ book, “Mastering the Market Cycle”. Howard Marks is the legendary investor who has led Oak Tree Capital Management for years. One of my critiques of the book was that Marks didn’t lay out a case for where we are now, in his opinion, though I noted that such was not the purpose of the book. This post will spell out where I think we are now.
I wrote that I like a roller coaster analogy better than Marks’ pendulum analogy. I believe that we are still in the “heading upward” part of the economic roller coaster. Others have said we are in the “late innings” of a rally that started 10 years ago. I don’t like the “innings” analogy because it implies that the game will soon end. I believe the economy still has room to run. GDP growth in the US has accelerated from the 2%-range to the 3% range. Unemployment has declined to 3.6%. Wages are up, albeit less than some may like. The 10-Year US Treasury Bond is in the 2.5%-range, which is not high enough to choke off borrowing. Such statistics are not indicative of a looming recession. The stock market is a leading indicator, and while it has its wobbles (mostly due to uncertainty related to world trade), it has touched record highs recently. Investors do not believe we are soon headed to recession, or else they wouldn’t be buying. Could things change? Of course, but the statistics are strong. Some investors will always believe we have had too much of a good thing and so they will sell at the first indication of trouble ahead. Howard Marks believes you can be a cautious buyer during an upswing such as I believe we are on now, and I agree.
Marks writes that, for every downturn, you can usually look back in time and see some sort of debt bubble. For instance, the last recession we had was caused by the subprime loan crisis. Now we have an emerging issue with student loans as default rates have risen. Not to downplay it, but the student loan bubble has been known for years. It will not sneak up on us like the subprime crisis did. $1.5 Trillion of outstanding student debt is a lot, but it pales in comparison with the $22 Trillion of US Government debt, plus the unknown Trillions of dollars of state and local government debt. Government debt is, I believe, the debt bomb that could sink us all. No country has ever been $22 Trillion in debt, so we don’t know what would happen if problems occur. So far, so good. Some cities have declared bankruptcy, but municipal bankruptcies have declined during the last 5 years. Some states don’t look particularly good (Illinois), and their debt has been downgraded. If and when the stock market crashes, I believe we will look back and point to growing government debt as having been the spark that lit the flame.
The other macro issue that has been written about (but not enough in my opinion) is aging and declining demographics. Other developed countries such as in Western Europe and Japan are really having trouble growing because their replacement birth rates are well below the 2.0 that is needed to sustain their own populations. The US is somewhat better off at 1.8 and is at about 2.0 when you factor in in-migration. It is very difficult to grow an economy more than 2% when your population isn’t growing. Speaking of government indebtedness, it is increasing difficult to fund Social Security and Medicare and other government programs that rely on younger people effectively paying for older people when there aren’t enough younger people paying into the system.
I believe we are still upward trending and we should all look to buy cautiously. Make sure your portfolios are diversified among asset classes, and certainly that you don’t have too much of your net worth tied up in the stock of one or just a few individual companies. The icebergs on the horizon aren’t stuff like trade with China or a 10 Year Treasury Note at a rate in excess of 3%. Instead, we should be watching to make sure our Federal, State and Local governments are still able to services their debts and that they (hopefully) don’t add too much to their already choking level of debt. We should also keep an eye peeled for even more declines in our birth rates as well as the ability to keep Social Security and Medicare solvent.