For decades, wealth managers and economists have placed considerable faith in the shimmering orb of leading economic indicators (LEI), confidently employing them to chart the trajectories of investment assets and the broader economy. Components of the LEI—such as unemployment claims, new durable goods orders, and consumer confidence—have served as steadfast navigational aids in guiding future decision-making. Historical paradigms suggested that the United States should have succumbed to an economic recession between mid-2022 and early 2024 at the latest. Yet, current coincident indicators (CEI) exhibit no signs of faltering. Despite the stock market’s function as an LEI component that typically forewarns of turmoil, many wealth advisors remain adamant in their reliance on LEI fluctuations to inform stock portfolio adjustments designed to mitigate Bear market threats. This cycle is distinct, propelled by unprecedented monetary and fiscal stimuli that have engendered consumption trends far exceeding trendline growth.
The LEI, disproportionately reflective of the modest manufacturing sector, which comprises merely 12% of GDP, has been clouded by inflationary supply chain interruptions induced by this excess stimulus. Such phenomena have engendered a spurious sense of economic contraction, as consumers transitioned their voracious Covid-induced spending from goods to services. The ensuing deceleration in consumption across all sectors, coinciding with declining inflation, casts a long shadow over consumers still reeling from the trauma of a 40-year high in inflation rates; however, this has not precipitated an actual contraction powerful enough to send workers cascading into unemployment. Today, the currently misleading LEI has depreciated to levels indicative of an economic nadir, rather than a harbinger of doom, even amidst an elevated stock market and an economy teetering on the brink of full employment. This bifurcation is unprecedented; current indicators not only eschew the role of lagging indicators but reach new monthly highs, while leading indicators have been on a downward trajectory for nearly two and a half years. Nevertheless, many forecasters continue to perceive the LEI and its individual components as ominous signs of impending economic and stock market calamities. We contend that present conditions should be interpreted as fortuitous. Should the LEI ultimately embark upon an anticipated upward trajectory, it is likely that the beleaguered consumer confidence levels would experience a commensurate uplift.
Additionally, the Small Business Profits Survey has been wielded by traditional forecasters to amplify their disquietude. The pronounced downturn in small business sales and earnings since late 2021 sharply highlights the burdens imposed by high inflation and steep borrowing costs upon this debt-laden, thinly resourced sector. Current earnings surveys are reminiscent of late 2008, a period synonymous with the waning of the Great Financial Crisis in housing. That juncture—late 2008 to early 2009—was fraught with trepidation, yet it also represented an opportune moment for investing in the stock market in anticipation of future economic resurgence. Thus, it strikes one as ill-timed to forecast another year or two of losses in the small business sector, as some tea leaf analysts suggest. In fact, when viewed in the context of prior survey extremes, we find ourselves on the cusp of an equity and economic renaissance rather than perilously perched on the edge of disaster. Serious equity market corrections will occur, but for now they will represent opportunities to increase leverage.
As economic growth begins to widen its focus beyond mega-cap technology firms, shifting this summer toward real estate, utilities, financial services, and industrials, small-cap companies appear positioned to transition toward a phase of enhanced profitability, especially as interest rates are projected to decline by 200 basis points over the forthcoming year. While a select cadre of trillion-dollar enterprises propelled the narrow Bull market forward in 2023, small-cap stocks languished in limbo for nearly two years before manifesting signs of vitality this summer. In recent months, these lower-valued stocks have oscillated between historic highs and the upper limits of their previous Bear market range. Thus, this sector stands on the precipice of a breakout within the next six months, likely to assume a leading role amid the anticipated heart of the interest rate decline.
