Hopefully, you’ve had a chance by now to check out this cult classic from 1994. It isn’t for everyone, but for those with eccentric Tarentino tastes, the script is as close to perfect as you get. The move is packed with interesting dialogue and engaging conversation. Heck there’s even two great lines on hamburgers alone; “a royale with cheese” and “thaaat is a tasty burger”. But what set the movie apart was the out of sequence fashion in which the movie was shot. With most movies, you follow a time line and you know where you are in the story. With pulp fiction, it’s not until you embrace the fact that you don’t know whether you are in the beginning middle or end that you take in all that great dialogue. What a great analogy for this difficult to track economic cycle.
Murky,
I have been to multiple talks this year highlighted with a discussion about where we are in this cycle and whether it is nearing its end. For a while, I would argue we had something resembling normalcy. The recession turned through the middle of 2009 with green shoots that turned into a full recovery with steady growth and sustained momentum through 2010. From then, in a “normal” economic cycle, you would expect optimism to kick in for both consumers and business and push us into a boom phase. But, for the last 5 years we have been stuck in a one step forward, two step back pattern, as every time we think we are on the verge of breaking out (remember the term “escape velocity?!?”), we are disappointed with yet another stalling pattern.
Weak,
Cumulatively, this start/stop pattern has added up to the weakest expansion in the modern era.
But Long Cycle.
The silver lining is that what we are lacking in strength, we are making up for in longevity. Well past 7 years old, this expansion is well past the 4.8 year average and is still chugging along. It’s easy to make an argument that those are related factors. A recession typically follows an overheating of some sorts – but there hasn’t been a whole lot that can be categorized as overheating? Longevity matters for a few reasons and I will give a couple of examples. First, losses are what make it so difficult to recover from. A very long period of sluggish growth is quite tolerable if you don’t have a steep cut somewhere along the way. Second, and a more nuanced, for those that normalize things over a 10 year period, we might very well soon have a 10 year period without a recession. This of course would include the Shiller CAPE ratio.
So where are we in the cycle now?
It’s clear to me (thanks, Mr. Obvious) that we are closer to end than beginning. The unemployment rate is down to 5% (once considered “full employment”), interest rates are on their way up and the yield curve is flattening. On the other hand, we might just very well be closer to the middle than the end. It’s incredibly important to have this open mind. Housing formation – with a gigantic millennial wave – could be one possible catalyst for a tailwind and run at securing a stronger economic growth period. Housing formation could lead to the big ticket expenditures and even credit expansion that could even nudge inflation. Or we might just stay in this one step forward, one step back pattern for the foreseeable future. That would not be the worst possible outcome.
So What?
Most important though is to take a lesson from pulp fiction and embrace the fact that we don’t know where we are in this story line. I believe a much better question for investors is to ask “what happens when” rather than simply “when”. At my firm, we have learned to embrace our inability to predict the cycle by relying on our risk barometer. Our philosophy is not built geared towards the avoidance of pullbacks or even corrections. The biggest key for in achieving this is to know our clients very well and to have them in the right strategy for their situation. The next biggest key though is our comfort in the quantifiable components we have incorporated into our risk barometer to guide our portfolios though a true turn in the cycle when the time comes.
