1st Quarter Commentary

“No amount of sophistication is going to allay the fact that all your knowledge is about the past and all your decisions are about the future.”

-Ian Wilson (1923-2014) Former Executive, General Electric

While it might sound obvious, we find it important to remember that knowing about the past only helps you place bets on the future to the extent that the future is like the past. People often make the assumption that the future will be like the past without even realizing it, but sometimes it just isn’t so. A great deal of the art of investing lies in recognizing when events are repeating previous patterns and when things truly are different.

We do not know for how long yesterday’s favorable conditions will extend into tomorrow. We do not expect many more years of breakneck wealth creation. We often think in terms of both the stock market and the economy as following a familiar cycle. Are we in the “high” part of the economic/market cycle?

  • Consumer confidence is at a 16-year high.
  • Small business confidence is at a 12-year high.
  • Stock market volatility is ultra-low. We recently had more than 100 days without a single one percent down day.
  • Fully one-third of small public companies lost money last year and no one seems to care (earnings before interest and taxes among Russell 2000 Index companies)1.
  • “Soft” economic data has been a lot stronger than “hard” data. This means that “soft data” which include surveys of consumers and producers about what they think is happening or about to happen, has been a lot stronger than “hard” data, which are direct measurements of some economic reality.

The final point is worth exploring. Models which use a lot of “soft” data are predicting GDP growth of 3% for the first quarter, while those restricted to hard data are predicting less than 1%; this is a huge difference. Sentiment has gotten ahead of reported economic reality; that much is clear. The question is whether (this time) sentiment is a leading indicator (meaning the hard data will follow) or is it a false flag (meaning expectations are over-hyped)?

The following chart makes us wonder how much of the improvement in soft data is politically related, and therefore perhaps less a reflection of current conditions on the ground. However, even if the economic confidence doesn’t reflect current conditions, such confidence can have a self-fulfilling effect on economic activity and shouldn’t be completely dismissed. Time will tell. If expectations prove overhyped, and aren’t followed by strong reported economic data, the stock market could stagnate or bleed lower. If the soft data is indeed a leading indicator and robust economic activity follows... will it be enough to exceed the already high expectations and push the market higher?

One fact that tempers our economic expectations and which many seem to ignore is that a major portion of GDP growth comes directly from population growth. As the below census data illustrates, population growth has been slowing for some time, with net migration representing half the total. Politics is unlikely to change this in a positive direction unless we start letting in more immigrants. We don’t think that’s very likely. For this reason alone, achieving a vaunted 4% real GDP growth rate will be an uphill battle.