It's Not Dark Yet

“It’s not dark yet…but it’s getting there.” –Bob Dylan

I am a firm believer that anyone who attempts to forecast the economy further than six months out is a charlatan. Six months or less, however, we can make a reasonable guess. So, six months ago or so if you had asked me whether there was a recession on the horizon, I would have replied I don’t see any clouds. Today that’s not true.

Today, I see clouds. They may not be in storm formation yet and they may completely dissipate, but they are there. This doesn’t mean we are headed into a recession within the next six months, just that the outlook has dimmed a bit.

Let me just focus on one of those clouds—the equity markets. The stock market is a component of the Leading Economic Indicators (LEI) gauge for a reason. The market is a discounting mechanism, meaning that investors are voting with their dollars on their expectations. Consequently, stock markets usually peak 1-4 months before a recession and bottom 1-4 months before the recovery. For, example the S&P 500 peaked in October of 2007 and the recession began in December. The index bottomed in March of 2009 and the recovery officially began in June.

Of course, markets go down for lots of reasons and every downturn is not necessarily indicative of a recession.

Still, here is why I am a bit worried: of the nine global equity classes we track, every single one of them is now below its long-term moving average. This means the trend has apparently shifted. This still could be a pause; simply a correction on the way to more highs. The fact that all are negative is at the least worrisome. It is one of the clouds.

So what does this mean for you? Check your portfolio allocation. Make sure you are comfortable with your stock allocation. Can you handle a 30-50% drop in equities if that happens?

In some of the advisory accounts we manage, we are at the lowest equity allocation we have been in years. This may be a head fake; after all, it’s not dark yet…but maybe it’s getting there.