This week Beth digs deeper on the stock market, recent economic growth, tightening labor markets and whether our growing federal budget deficits should keep us up at night. While all economic indicators seem to be flashing "green," last week's stock market tumble might signal less rosy times ahead (or maybe it's just a brief respite after a sharp rise in January). Beth asks some great questions to spur classroom discussions!

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Anyone else concerned about how long the “good” economic news will keep going?  Nobody seems to be, and James Mackintosh of the WSJ explains why this could be worrisome.   Note: If you don’t feel like reading the entire article, watch the video interview of David Rubenstein of the Carlyle Group at Davos last week—he sums things up quite clearly.  

Have people forgotten the run-up to the Great Recession?  What is going on with the stock market?  The market seems to be cooling off this week after a year of record-breaking highs, but despite the 2.5% tumble it took on February 2, it is still up for 2018.  Is this the beginning of the end? Perhaps it reflects a little profit-taking by those who ARE a little skeptical as GDP rose at a slightly lower rate in the 4th quarter.  Friday’s drop was reportedly the result of increased concerns about inflation picking up after the jobs and wage data came out [200,000 jobs and hourly earnings up 2.9%, best since 2009].

For those looking for a sign of a market top, people have been posting pictures of their 401k balances on social media.   And individual investors are jumping into the market, especially younger investors interested in things like cryptocurrencies.  

“There’s pent-up activity and some element of the fear of missing out,” said Devin Ryan, a brokerage analyst and managing director at JMP Securities LLC, especially among younger investors as the stock market continues to hit highs.

Even great minds disagree on all of this, so it is little wonder that regular folks don’t know what to think and may get caught up in the exuberance.  Is it “Irrational Exuberance”?

What is 'Irrational Exuberance'

For those of you who weren’t financially aware in the 90’s to remember the introduction of this phrase, Investopedia defines it as follows.

Irrational exuberance is unsustainable investor enthusiasm that drives asset prices up to levels that aren’t supported by fundamentals. The term “irrational exuberance” is believed to have been coined by Alan Greenspan in a 1996 speech, “The Challenge of Central Banking in a Democratic Society.” He said that low inflation reduces investor uncertainty, lowers risk premiums and implies higher stock market returns. 

In fact, we have experienced an extended period of low inflation and higher stock market returns.  Interest rates and bond yields have been low, which made people look to stocks for higher returns (and bids up stock prices.)  Do the fundamentals support the high values?  Did you notice that Treasury bond yields crept up at the end of last week as stock prices dropped?

First of all, let’s set the record straight about one thing.  Only half of Americans actually own stock in any form: individually or jointly, directly or through a mutual fund, 401k or IRA, according to a recent Gallup poll.  So, half the country is not getting any wealthier from the market performance.  And in 2016, the richest 10% of Americans owned 84% of all stocks.   

What should you do to manage your investments? An article from last week’s reading list might provide you with some comfort and guidance on investing in these times. Burton Malkiel (author of A Random Walk Down Wall Street) gives his advice for investing in these conditions.  Bottom line, according to Malkiel:

Two strategies that work: broad diversification and rebalancing. Also, try to minimize your costs.

The Economic Picture

Growth and savings

Growth in the US appears to be consumer driven.  Consumers are spending money [and putting a lot of it on their credit cards as VISA's strong quarter indicates].  And now for one of those counter-intuitive economic realities: the consumer spending spree resulted in a drastic rise in imports in the fourth quarter of 2017, and since imports are DEDUCTED from GDP, this caused the GDP growth to DROP to 2.6% from 3.2% in the third quarter.

GDP proves to be an imperfect measure of our economic well-being.  What does GDP measure? We just learned that imports are deducted (exports added). Did you know that it measures things like arms production as a positive contribution, but doesn’t reflect things like clean air or quality of healthcare?  Furthermore, as an aggregate measure, it does not reflect inherent and growing inequality.  But I digress…read this Time Viewpoint for more on the subject.

Moving on to another confusing measure, the savings rate in the US is at the lowest rate (2.4% in December) since before the Great Recession (2005). People feel wealthy (showing off their 401(k) balances on social media, anyone?) so they spend more (consumer-driven growth) and save less.  Does it matter?  It seems rational, but….

Unemployment and wages

Another explanation for growth in consumer spending and a decline in the savings rate...the job market. 

After a prolonged period of stagnation, have wages finally started to rise? January data suggest yes, but the increases are uneven.  With unemployment at record low rates, economists wonder why real wages aren't increasing faster?  Will the corporate tax cut finally mean wages will go up more broadly?  This NYT article sheds some light on what is going on and is worth the read. Continued  sluggish productivity growth is part of the equation.

Tax cuts and deficits

[Editor's Note: What makes this tax cut interesting is that it is coming at time of tight labor markets and strong economic growth...will it keep the good times rolling or lead to higher than expected inflation which may curtail the party.]

The tax cut will add a projected $1.5 trillion to the deficit over the next 10 years. The impact is being felt immediately, as Treasury Secretary Mnuchin has asked Congress to raise the debt ceiling based on the latest CBO projection:

The Congressional Budget Office on Wednesday moved up its projection for when the Treasury will likely run out of cash to the first half of March, citing lower government revenues after the Republican overhaul of the U.S. tax system in December.

At what point does the deficit start to matter?   A graph shows that the US at just over 100% debt/GDP ratio has a ways to go before it ends up in Japan’s boat.  For Japan, a ratio of 240% DOES matter.  They suffered from years of a stagnant economy and deflationary periods.  Extreme fiscal measures did little to help until very recently (the last year or so).  

If you were reading this looking for answers, you may be disappointed.  I posed more questions than I answered, but you are now hopefully more informed about how the recent headlines about the markets and the economy are all interrelated (and why economic forecasting is so difficult!)  

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