No Recession On The Horizon

High Valuations & Exuberance Are The Main Bearish Arguments

The best argument the bears have is valuations are too high as the stock market continues going up. Personally, I can’t see stocks falling with this type of earnings momentum and economic growth. That being said, the Shiller PE is at 31.9 which is close to the peak in 1929. I don’t buy the argument that the Shiller PE could be lower when the earnings in 2008 are lapped out of the 10 year metric because the entire point of the Shiller PE is that it uses actual earnings results. If you start taking into account the projections, it becomes a forward multiple which isn’t the point of the metric. Keep in mind, that the 2008 earnings are fully out of this metric in the spring of 2019; that’s still far off in the distance.

Besides high valuations, the other issue is the heightened exuberance in the market. I would call this rational exuberance because investors have reason to be exited as the S&P 500 has record earnings and the economy in 2017 might grow close to 3%. Staying in tune with this point of rational exuberance, the chart below shows the U.S. household and non-profits’ exposure to equities. As you can see, the exposure in 2017 is near the peak in 2007. In the next few months, it will probably surpass that peak. The only other period with higher exposure was the bubble in the 1990s. Given the heightened speculation in cryptocurrencies, I expect the equity exposure will never get to the 1990s levels because the real speculation is occurring in cryptos, not stocks. I think cryptos have a while to run because their total size is dwarfed by just one of the tech giants in the 1990s, but that’s a discussion for another article.

Yield Curve & Personal Savings Additional Arguments

The next argument that the bears have is the flattening yield curve. Currently, there isn’t much of an argument because it isn’t inverted. However, it is slightly disconcerting to see how it is quickly flattening while such great economic reports come out. It’s possible that the yield curve is flattening because of the fast growth. The economy is moving from the Goldilocks scenario to overheating. It’s not there yet, but inflation usually comes after growth accelerates. The yield curve tells me growth will accelerate in 2018, causing inflation. Then a recession will occur in 2019 or 2020. Given that perspective, there’s nothing negative that the yield curve is saying just yet. The chart below compares the yield curve to the real disposable income growth per capita. Not surprisingly, inversions forecast declines in real disposable income. I’m expecting real disposable income to increase in 2018 because of wage growth. However, that can change by the end of the year because inflation might pick up.

Speaking of the disposable income of the consumer, the chart below shows the personal savings rate. As you can see, the savings rate is near the lows last seen in 2007. Part of the decline in the savings rate is because of low interest rates. The low rates encourage people to spend more money. Consumers focus too much on nominal rates instead of real rates because interest rates are easy to see while inflation stats aren’t as easily obtained without doing research. Low inflation means the dollar will have more spending power, but most don’t see it that way. This low savings rate won’t matter unless the economy falters and job losses mount. On the bright side, the consumer debt isn’t as high as last cycle because the mortgage debt isn’t as high. Higher interest rates would put a damper on their ability to pay back loans and increase the savings rate, but for now we’re in a good spot. In the long run, heightened savings is good because it allows for more investment. However, in cyclical terms, the savings rate going down is good because it means the consumer is confident.

No Recession In 2018

I even mentioned that there wasn’t going to be a recession when discussing the bearish arguments. That shows how much momentum the economy has. As you can see in the chart below, on a net basis over 45% of economic indicators are accelerating. It’s surprising to see this chart showing deceleration in the middle of the year since Q2 GDP grew 3.1%. Either way, the chance of a recession has been at zero the entire year. The indicator was above 50% for most of 2016 because of the global trade weakness, the energy price collapse, and the industrial recession. The economy came close to a recession, but didn’t get there, making everyone who expected one, like myself, look bad.

2018 Forecasts

We’re at the end of the year which means everyone is coming out with their projections for next year. The list below shows the forecasts for various economic data points from the Chicago Fed’s Outlook Symposium. The first thing that jumps out is that this forecast shows real GDP growth will slow next year. That’s surprising given the economy’s momentum. I think the 2017 GDP forecast will prove to be pessimistic because of the latest upward revision to Q3 GDP. I expect 2017 GDP growth to be between 2.6% and 2.8%. I also think the 2018 estimate for car and light truck sales is too high. It’s doubtful the rate gets to the 2017 level, given the fact that this year’s number was juiced by the hurricanes causing more people to replace their destroyed cars.


I highlighted some of the top bearish arguments. Even if you take a negative perspective, there’s no reason to sell stocks in 2018 or go short. There is euphoria in the market, but I will stay bullish until the euphoria stops being justified. The recession index is rightfully at zero as 2017 is about to end on a high note with GDP growing above 3% in Q4. Stay the course for the next 6 months.

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1 Comment

  • Michael Jones

    December 6, 2017

    I believe this is correct and look forward to seeing what the NQ does starting next week with regards to finishing out this year.