Before Thunder, There’s Lightning

32964132_s A few weeks back, a Cutter Family Finance faithful, let’s call him John, reached out to me via e-mail. The gist of John’s e-mail was to defend his outdated investment strategy. He admitted to me that he has no downside risk management triggers in place, (which you all know I believe are necessary). He also said that I can be rather pessimistic when I write about our economy. John believes that the markets will continue to rise. He argued that people are buying stocks “since there’s no other choice” and foreign investors are moving to dollar denominated holdings, which is also helping to fuel the markets.
 
John, I guess there is some truth to both of those theories but I must tell you, as I read about and watch the markets, I am perplexed by what is going on with our economy and what is happening with equities. And I will tell you that in any brewing storm cloud, there is always lightning before there is thunder. As the storm cloud threatens, some will see the lightning and seek shelter, while others won’t. As Forrest Gump once said, “… and that’s that.”
 
So let’s take a look at some data. We saw the first bolt of lightning when the Bureau of Economic Statistics (BES) issued the gross domestic product report for the first quarter of 2015. This report shows us that for the first three months the economy grew at an annual rate of a whopping .2 percent. Now John, if my math is correct, that works out to .05 percent for the quarter (.2 divided by 4).
 
I just want you to think about this for a moment. For six years Uncle Sam has printed over $4 trillion, mortgages are still being issued with minimal down payments required, and as I write this column, mortgage rates are still hovering between 3 percent and 4 percent. With all of this, our economy should be growing at 3 to 4 percent, not .05 percent, which is as close to zero as you can possibly get before you go negative.
 
The Bureau of Economic Analysis (BEA) are the financial wizards who estimate GDP and frankly, they have been wrong at just about every turn for the past five years. To make matters even more daunting, the Board of Governors at the Federal Reserve bases many of its economic decisions on the information it receives from the BEA. So, in the fourth quarter of 2010, while the Fed issued the second round of quantitative easing, those financial wizards at the BEA predicted in 2011, 2012 and 2013 the economy would grow at rates of 3.3 percent, 4 percent, and 4 percent, respectively.
 
After the actual numbers for 2011 came in at a mere 1.6 percent, which was about half of what was predicted, the wizards went back to the drawing board and came back to us in January 2012 with revised estimated growth rates of 2.5 percent, 3 percent, and 3.7 percent for years of 2012, 2013 and 2014. Nope, wrong again. The year 2012 actually came in at 2.3 percent, which was close to the revised 2.5 percent estimate, compared to the original estimate of 3.3 percent. But the numbers were not so close for 2013 and 2014. GDP only grew at 2.2 percent for 2013 and 2.4 percent for 2014.
 
Hmm. John, are you beginning to see the problem here?
 
Here is my point. No matter what we have done to spur lending and borrowing, the truth is that there is virtually no economic growth in our economy. The most recent bolt of lightning was seen in the equity markets over the past several weeks. This may be an indication that we are not in a clear weather pattern.
 
The only positive is that because the economy is so weak, even with all the stimulus and entitlements, the Fed might not move short-term rates off zero for a while.
 
Folks, with six years of strong equity growth without a significant correction, and with the US continuing to suffer from weak economic growth, the chance that we will hear the thunder seems to grow with each passing day.
 
John could be right, the markets could break through this recent volatility and continue to rise. But what if he’s wrong?
 
I left John with these closing thoughts that I will share with you. Before thunder there is lightning. Now is not the time for added risk or speculation within your investments. While we can never predict the future of the financial markets, now is a good time to review your investment system. Make sure to back test your system to see how it behaved in 2008. What happened? If you suffered significant losses, you must ask, why? Is it possible that your system is broken?
 
When the rain clouds open, it may not be just a passing shower, it could quickly turn into a flood.
 
Be vigilant and stay alert, because you deserve more.