Dangerous Words

| June 30, 2023

Is it different this time around? Renowned investor Sir John Templeton famously said that “this time is different’ are among the most costly four words in market history.” That is because there are always good reasons to believe that today is different from yesterday. We seize on small qualitative differences to reassure ourselves that our bullishness results from careful analysis. Internet stocks supposedly ushered in a new paradigm. Then real estate was so different from internet stocks that we needn’t have worried about a recession. God isn’t making any more land people quipped. Never mind that most American “panics” resulted from real estate speculation.*

I thought about this while perusing the latest Leading Economic Index (LEI) release from the Conference Board.** The index hopes to anticipate future trends in the economy by tracking three financial components and seven non-financial components. According to their website, “the US Leading Index has declined in each of the last fourteen months and continues to point to weaker economic activity ahead.” In May, the LEI declined by 0.7 percent and “is down 4.3% over the six-month period between November 2022 and May 2023—a steeper rate of decline than its 3/8% contraction over the previous six months from May to November 2022.”

Of the three financial components, only the S&P 500 is positive. Among the non-financial components, building permits are significantly positive while new orders for nondefense capital goods (ex-aircraft) and manufacturers’ new orders for consumer goods and materials are barely positive. Consumer expectations and new orders have sharply deteriorated.

The LEI has limited use for trading since the index can deteriorate for years before a recession hits. It began turning down in 2003 and bounced up again in 2006 after grazing the warning signal. That proved to be a head fake when the LEI collapsed in 2007, shooting past both the warning signal and the recession signal as 2008 began. The collapse didn’t begin until that September. We shot far past the recession signal this May.

As always, there are many reasons to believe that “this time is different.” Pandemic stimulus is still in the economy. Inflation Reduction Act subsidies are yet to be felt. Artificial intelligence promises changes to how we live and work that are barely rivaled in history. Earnings are not as bad as expected and neither is the economy. Jobs are still plentiful and real estate is holding up in many places. This seems like a Goldilocks scenario. Maybe this time is different, but that is not what the LEI is showing.

I do not think that we are headed for a 2008/2009 meltdown. I do believe that we are in a similarly slow-motion recalibration of the economy. Despite the recent rally, the S&P 500 TR USD is still down -6.7%, and the Nasdaq 100 TR USD is down -8.18% from the end of 2021 (as of June 23). That includes dividends.

I expect some bullish sentiment to continue against a backdrop of extremely heightened risk. I do not believe the popular narrative that the Fed is almost done tightening or that significant rate cuts are on the horizon. Investors had a long runway to reduce risk in both the dot-bomb period and the real estate mania. We have a similar opportunity today to reduce leverage and get paid for the effort.

* https://sirjohntempleton.org/

** https://www.conference-board.org/topics/us-leading-indicators