Investing and the Economy City of Burlington Barry Bryant, CFA May 10th, 2018 New York Massachusetts Pennsylvania Texas Florida
Overview • Will increasing debt reduce economic growth? Can useful investment insights be gleaned from that relationship? • What investments have done well in past recessions? • Where is the economy now? What indicators might answer that question and yield useful investment insights? 1
Debt The United States has an increasing deficit financed with debt. • Interest payments on debt will account for ~7.4% of our 2018 • budget, rising to 12.2% by 2028 if nothing changes. Some economists believe debt can slow economic growth. • 2
Economic Consequences of Debt Some economists believe rising debt/GDP reduces economic growth • Reinhart and Rogoff (R&R) did a comprehensive study of worldwide • economies going back decades Original work showed negative economic growth with debt/GDP > 90% – Modifications suggest growth slows to 2.2% when debt/GDP exceeds 90% – Debt added faster under Obama than any president since 1966 • Debt/GDP crossed 90% in 2011 – GDP growth under Obama was sub 3%, slowest in any economic recovery – R&R, combined with Simpson Bowles, used to criticize federal spending – Debt/GDP will reach 110%-140% in 10 years depending on growth – 3
Debt/GDP – 3.5% GDP Growth 4
Debt/GDP – 2.5% GDP Growth 5
Debt/GDP – 1.5% GDP Growth 6
Relationship between S&P 500 and GDP Year GDP S&P 500 Year GDP S&P 500 Year GDP S&P 500 1930 -8.5 -24.9 1961 2.6 26.9 1987 3.5 5.3 1931 -6.4 -43.3 1962 6.1 -8.7 1988 4.2 16.6 1932 -12.9 -8.2 1963 4.4 22.8 1989 3.7 31.7 1933 -1.3 54.0 1964 5.8 16.5 1990 1.9 -3.1 1934 10.8 -1.4 1965 6.5 12.5 1991 -0.1 30.5 1935 8.9 47.7 1966 6.6 -10.1 1992 3.6 7.6 1936 12.9 33.9 1967 2.7 24.0 1993 2.7 10.1 1937 5.1 -35.0 1968 4.9 11.1 1994 4.0 1.3 1938 -3.3 31.1 1969 3.1 -8.5 1995 2.7 37.6 1939 8.0 -0.4 1970 0.2 3.9 1996 3.8 23.0 1940 8.8 -9.8 1971 3.3 14.3 1997 4.5 33.4 1941 17.7 -11.6 1972 5.2 19.0 1998 4.5 28.6 1942 18.9 20.3 1973 5.6 -14.7 1999 4.7 21.0 1943 17.0 25.9 1968 4.9 11.1 2000 4.1 -9.1 1944 8.0 19.8 1969 3.1 -8.5 2001 1.0 -11.9 1945 -1.0 36.4 1970 0.2 3.9 2002 1.8 -22.1 1946 -11.6 -8.1 1971 3.3 14.3 2003 2.8 28.7 1947 -1.1 5.0 1972 5.2 19.0 2004 3.8 10.9 1948 4.1 5.5 1973 5.6 -14.7 2005 3.3 4.9 1949 -0.5 18.8 1974 -0.5 -26.5 2006 2.7 15.8 1950 8.7 31.7 1975 -0.2 37.2 2007 1.8 5.5 1951 8.1 24.0 1976 5.4 23.9 2008 -0.3 -37.0 1952 4.1 18.4 1977 4.6 -7.2 2009 -2.8 26.5 1953 4.7 -1.0 1978 5.6 6.6 2010 2.5 15.1 1954 -0.6 52.6 1979 3.2 18.6 2011 1.6 2.1 1955 7.1 31.6 1980 -0.2 32.5 2012 2.2 16.0 1956 2.1 6.6 1981 2.6 -4.9 2013 1.7 32.4 1957 2.1 -10.8 1982 -1.9 21.5 2014 2.6 13.7 1958 -0.7 43.4 1983 4.6 22.6 2015 2.9 1.4 1959 6.9 12.0 1984 7.3 6.3 2016 1.5 12.0 1960 2.6 0.5 1985 4.2 31.7 2017 2.3 21.8 1986 3.5 18.7 7
Relationship between S&P 500 and GDP 8
Relationship between S&P 500 and GDP 9
Recession Investment Each of the last 4 recessions had a different origin • No single asset class provided safety in all four • When interest rates decline…bonds • When economic growth lies ahead…stocks • When recession is a real melt down…gold • 10
Recessions’ Unique Characteristics Recession Year Best Investment? Reason for Recession 1981 Domestic Fixed Income Reagan/Volker, interest rate decline drove bonds up 1990 Domestic Equity Classic mild recession (Bush) follwed by expansion (Clinton) 2001 Gold Techology bubble burst, 9/11 2007 Gold Housing collapse destroyed financial institutions Year 1 Year Forward 3 Years Forward 5 Years Forward 1981 Domestic Fixed Income Domestic Fixed Income Foreign Developed Equity 1990 Domestic Large Cap Equity Domestic Small Cap Equity Domestic Large Cap Equity 2001 Gold Gold Gold 2007 Domestic Fixed Income Gold Gold 11
1981 Recession Recession Began July 1981 Characteristics The Iranian Revolution sharply increased the price of oil around the world in 1979, causing the 1979 energy crisis. This was caused by the new regime in power in Iran, which exported oil at inconsistent intervals and at a lower volume, forcing prices up. Tight monetary policy in the United States to control inflation led to another recession. The changes were made largely because of inflation carried over from the previous decade because of the 1973 oil crisis and the 1979 energy crisis. 1 Year Forward 3 Year Forward 5 Year Forward Domestic Large Cap Equity -11.55 (4) 10.76 (4) 19.32 (3) Domestic Small Cap Equity -18.85 (6) 16.25 (2) 20.35 (2) Foreign Developed Equity -12.17 (5) 6.75 (6) 40.42 (1) Real Estate 13.01 (3) 12.06 (3) 11.06 (5) Gold -25.91 (7) -15.74 (7) -11.28 (7) Domestic Fixed Income 20.54 (1) 16.89 (1) 19.18 (4) Cash 13.92 (2) 10.76 (5) 9.64 (6) 12
1990 Recession Recession Began July 1990 Characteristics After the lengthy peacetime expansion of the 1980s, inflation began to increase and the Federal Reserve responded by raising interest rates from 1986 to 1989. This weakened but did not stop growth, but some combination of the subsequent 1990 oil price shock, the debt accumulation of the 1980s, and growing consumer pessimism combined with the weakened economy to produce a brief recession. 1 Year Forward 3 Year Forward 5 Year Forward Large Cap Equities 12.76 (1) 11.41 (3) 12.9 (1) Small Cap Equities 1.17 (4) 13.51 (1) 12.88 (2) International Equities -8.16 (7) 2.92 (5) 5.99 (4) Real Estate -2.81 (5) -4.53 (7) -0.46 (6) Gold -7.21 (6) -1.06 (6) -3.56 (7) Domestic Fixed Income 10.7 (2) 11.86 (2) 9.06 (3) Cash 6.63 (3) 4.68 (4) 4.57 (5) 13
Early 2000’s Recession Recession Began March 2001 Characteristics The 1990s were the longest period of growth in American history. The collapse of the speculative dot-com bubble, a fall in business outlays and investments, and the September 11th attacks, brought the decade of growth to an end. Despite these major shocks, the recession was brief and shallow 1 Year Forward 3 Year Forward 5 Year Forward Large Cap Equities 0.24 (6) 0.63 (7) 3.97 (6) Small Cap Equities 14.07 (2) 10.93 (2) 12.61 (2) International Equities -8.22 (7) 3.8 (5) 10.04 (4) Real Estate 3.81 (4) 6.81 (4) 11.15 (3) Gold 14.79 (1) 16.18 (1) 14.87 (1) Domestic Fixed Income 5.35 (3) 7.44 (3) 5.11 (5) Cash 2.55 (5) 1.65 (6) 2.11 (7) 14
Great Recession Recession Began December 2007 Characteristics The subprime mortgage crisis led to the collapse of the United States housing bubble. Falling housing-related assets contributed to a global financial crisis, even as oil and food prices soared. The crisis led to the failure or collapse of many of the United States' largest financial institutions: Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, Citi Bank and AIG, as well as a crisis in the automobile industry. The government responded with an unprecedented $700 billion bank bailout and $787 billion fiscal stimulus package. The National Bureau of Economic Research declared the end of this recession over a year after the end date. The Dow finally reached its lowest point on March 9, 2009 1 Year Forward 3 Year Forward 5 Year Forward Large Cap Equities -36.01 (6) -2.89 (5) 1.64 (4) Small Cap Equities -33.79 (5) 2.22 (3) 3.55 (3) International Equities -43.06 (7) -6.55 (6) -3.21 (7) Real Estate -10.01 (4) -9.71 (7) -1.09 (6) Gold 2.36 (2) 17.3 (1) 13.39 (1) Domestic Fixed Income 5.24 (1) 5.91 (2) 5.96 (2) Cash 1.28 (3) 0.52 (4) 0.35 (5) 15
Economic Indicators Leading economic indicators are positive. • Most show economy growing at an accelerating rate. • Interest spread suggests market does not believe continuing • positive growth. Money velocity may turn negative if labor markets tighten. • 16
Economic Indicators - Summary # Indicator Current Trending 1) Consumer Spending Strongly Positive Positive 2) Interest Rate Spread Positive Negative 3) Housing Permits Positive Positive 4) Money Supply Neutral Negative 5) Stock Market Positive Positive 6) Manufacturer’s Orders Strongly Positive Negative 7) Unemployment Claims Strongly Positive Positive 8) Average Hours Worked Mildly Positive Negative 9) Vendor Deliveries Positive Positive 17
Consumer Sentiment Definition: The consumer confidence index is published monthly by the University of Michigan. Each • month at least 500 telephone interviews are conducted of a continental United States sample to gauge consumer attitudes and expectations. Significance: It assesse consumer attitudes on business climate, personal finance, and spending. • Changes in these attitudes have been seen in the index before seeing them in the overall economy. Rising sentiments supports increasing consumer spending. Statistics: • Current: 99.7 – Average 85.8 – Maximum: 112.0 – Minimum: 51.7 – Current Indication: • Strongly Positive, Trending Positive – 18
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