At Astor, we have an analogy we like to use from time to time to put into perspective our view of economic/political/fiscal, etc. events and how the market and economy may react to them. When a healthy person contracts pneumonia, they get sick no question, but through normal processes of the immune system, they resume normal functions in short order. A patient with an already compromised immune system that contracts pneumonia becomes very sick and takes an extended period to recover, and may even die. At Astor, our job is to diagnose the health of the economy.
Astor utilizes our long-tested proprietary analytic measurements to determine how healthy the patient is (patient being the economy). We measure what we consider to be the major vital signs of the macro economy and financial markets (employment, output, interest rates, market performance) and determine if the economy is healthy enough to support rigorous activity. Can we support higher risk asset prices from here or not, and to what degree of probability? Our background, experience and research have enabled us to position these figures in such a way as to provide a relevant perspective and practical framework for an investable and executable solution for client portfolios.
This isn’t a healthcare blog obviously, so what am I getting at? Follow this example with me if you will. In 2007, we started seeing signs of a declining economy, and by Q2 2008, we had reduced our exposure so significantly that we had a defensive position on the economy and the markets. The excessive borrowing and loose regulation and oversight of credit creation was like a virus already reproducing in the global economic system. The economy was already slowing down and most likely headed toward a recession. When the events of Sept/Oct 2008 happened with Lehman Brothers and the collapse of other financial institutions, this was the virus being acquired by the sick patient, and it almost died.
In 2010, the global economy was in initial recovery mode, still showing symptoms but in general feeling active. In April and May that year, we experienced two distinct shocks to the system – one in the form of a sovereign debt crisis in Europe and the other a flash crash in the U.S. financial markets. One technical and one economic, however both were issues. The point to note is that the economy was actually growing and recovering here in the U.S. during that period, and it was healthy enough to absorb these events. Now, this is not to say that the sovereign debt crisis did not have an economic impact globally, as it did. It speaks to the ability of economies to handle negative inputs when they are growing, or at least stable and not decelerating.
So what does this all mean for where we are today? We have clearly contracted a virus called “Washington-impasse”. We also have a cold called “sudden interest rate acceleration”. If that isn’t enough, we are still feeling the lingering effects of sequestration (oh, that’s still Washington, isn’t it?). The economy suffered some fits and starts this year, but as of the most recent data, we have seen readings from broad based economic measures such as ISM Manufacturing PMI, Chicago PMI, ISM Non-manufacturing that are at multi-year highs or top end of the range, as well as post- recession lows in jobless claims. Additionally, this time around, Chinese PMI/economic activity appears to be stabilizing and Western Europe has shown increasing evidence of emerging from its multi-year recession. These factors should all act as support beams from fiscal stress.
What’s occurring in Washington will create disruption in the markets, and frankly should more than it has. The markets have brushed off fiscal drags for the past two years, and now that a short-term compromise has occurred it has the opportunity to do the same. The ripple effects of the initial government shutdown are being felt in elevated claims numbers and corporations are adjusting guidance already for Q4 revenue. This will have an impact to Q4 GDP and the consumer, but the result may be transitory. The bottom line is if the economy is gaining steam despite the headwinds finally, and recent numbers have suggested as much, it will absorb these shocks. This does not mean volatility will not exist and markets can’t react adversely short term, but those are the unknowns and timing them is difficult. If there is truly more to this movie than a temporary, we’ll know. We measure this patient’s vital signs every week. If it shows up with a fever, we stand ready to help our clients minimize the effects.