Second Hand News: Facing a Second Derivative Economic Inflection Point?

Key Points

  • U.S. economic growth is strong; but it’s time to look at the signs we may be facing a “second derivative” change, or inflection point in growth.

  • Complacency abounds—about growth, volatility, inflation and trade.

  • Heed this: when it comes to the relationship between economic fundamentals and stock market behavior, “better or worse matters more than good or bad.”

This report may end up being the first in an ongoing series. I think of it as a “look inside my notebook,” as it literally represents a synopsis of the recent notes I put together for our latest Asset Allocation Working Group meeting. These represent a number of budding risks for the economy with which the markets are grappling. There are offsetting positives of course, but let’s leave this report to a look at some of the possible negatives.

Second that emotion

In particular, I will highlight some risks associated with “rate-of-change” or “second derivative” movements in indicators. These are directly tied to my long-held motto that when it comes to the relationship between economic fundamentals and the stock market, “better or worse tends to matter more than good or bad.” In other words, rate of change and inflection points matter more than levels.

Let’s start with a positive actually, but one that begs the question: “Is this as good as it gets?” The U.S. economy has been accelerating for eight consecutive quarters—using the year/year growth rate of real gross domestic product (GDP) on a quarterly basis. Yes, it’s still not at a strong level relative to past peaks, but eight quarters with consistently accelerating growth from quarter-to-quarter has never happened before, as you can see in the chart below. The prior record was seven, coming out of the 1991 recession. Perhaps the streak continues, but I think there’s a risk that it will end in this year’s second half.

Record-Breaking Run for Accelerating Growth

Source: Charles Schwab, Bureau of Economic Analysis, FactSet, as of June 30, 2018.