My biggest complaint in regards to the current economic expansion is that it hasn't been standing on its own two feet but, rather, hanging completely on the twin shoulders of Uncle Sam and Uncle Ben. Without the massive fiscal stimulus from the Obama Administration and two rounds of quantitative easing by Fed Chairman Ben Bernanke, it is highly unlikely that we would have had much, if any, recovery; arguably, the current expansion has been entirely artificial. What is missing so far is strong job creation—a characteristic of true self-sustaining recoveries—and a subsequent decline in the unemployment rate. As there has been no real job creation for much of the last two years, consumer sentiment has been at recessionary levels, which is no surprise. However, this may be about to change as the engine of job growth, small businesses, are becoming more optimistic.
The recovery that began in 2009 has predominantly been a Wall Street and emerging market recovery story while Main Street largely has believed the recession never ended. The stock market is up more than 80%, corporate profits are surging, and many emerging market stock indexes are making all-time highs as if 2008 was just a blip on the radar screen, yet we have an unemployment rate near double-digit territory and very little in terms of true job creation and income generation. The following chart of the National Federation of Independent Business (NFIB) Optimism and Hiring Indexes (top panel) and consumer confidence (bottom panel) shows that when small businesses are not confident about the economy or their businesses they do not hire which leads to depressed consumer confidence.
Source: Bloomberg
What piqued my interest last week was the November release of the NFIB Small Business Survey which showed a spike in the Optimism Index and a spike in the net percentage of companies who plan to increase employment. This is likely being reflected in the consumer sentiment numbers in the chart above. I bring this up because we may finally start to see the "normal," not "artificial," business cycle begin. That said, even if the normal business cycle kicks in I believe a prolonged expansion is definitely not in the cards (see prior post, “Expect More Boom and Busts”). The phases of the business cycle start with employment, then income, then confidence levels, and finally consumption. The linkage between employment, income, confidence and consumption are shown below and I am watching the trend in small business hiring index for an acceleration ahead.
Source: Bloomberg
I feel there is a good chance that the economy may begin to find its legs next year if hiring by the small business community begins in earnest. The fact that the Economic Cycle Research Institute's (ECRI) Weekly Leading Index (WLI) is now almost back above zero is a positive development. Since summer the WLI has been steadily improving each week and as seen by the chart below there is a good correlation between the stock market and the WLI.
Source: Bloomberg
It is important to stay objective and, as Keyens put it, “When the facts change, I change my mind. What do you do sir?” One very big complaint I have to the bears out there is that they were touting the large decline in the ECRI WLI earlier this year as proof of a coming double-dip recession. I too took note and agreed with the bears that we had a good chance of an impending recession (see “From Green Shoots to Falling Fruits”). However, the WLI bottomed this summer and has snapped back sharply, and the same bears pointing to its decline have conveniently ignored its recovery. While I was in the double-dip recession camp earlier in the year, when the facts changed so did I (see “Investment Implications of a Bottom in Leading Economic Indicators”).
As long as the WLI continues to rally I will remain optimistic on the economy and the stock market. The WLI has proven an excellent risk management tool. Notice in the figure above that the WLI peaked in 2003 well before the 2004 consolidation. It peaked in 2007 ahead of the stock market and it bottomed in 2008 ahead of the 2009 March lows. Additionally, the WLI peaked in 2009 well before the sharp summer correction we had this year. Until the WLI rolls over I will continue to be bullish on the markets overall. That said, even in June/July we had a correction in the stock markets despite the WLI continuing to rise, which was simply a technical correction in which the stock market digested its recent gains. I can envision such a scenario again on the intermediate horizon and will remain alert for a potential correction ahead (see “Intermediate Term Correction on the Horizon?”), but a correction aside, the trend is undeniably bullish and I plan to stick with the trend.
