If you’re using economic indicators to determine your allocation to the stock market, you will most certainly be well behind the curve
An Elliottwavetrader member attended the 32nd Economic Outlook Symposium hosted by the Federal Reserve Bank of Chicago in November. On the first day, he sat in a room with 150 economists. When asked how many see a recession in 2019, two hands went up.
So let me ask a question: When was the last time the majority of economists correctly called for a recession? (I think we all know the answer to this one.)
In fact, economists are the last people to see recessions coming. And by the time they do, recessions are almost over.
I have often quoted Professor Hernan Cortes Douglas, a former Luksic Scholar at Harvard University, former deputy research administrator at the World Bank and former senior economist at the International Monetary Fund), who’s worth listening to:
“Financial markets never collapse when things look bad. In fact, quite the contrary is true. Before contractions begin, macroeconomic flows always look fine. That is why the vast majority of economists always proclaim the economy to be in excellent health just before it swoons. Despite these failures, indeed despite repeating almost precisely those failures, economists have continued to pore over the same macroeconomic fundamentals for clues to the future. If the conventional macroeconomic approach is useless even in retrospect, if it cannot explain or understand an outcome when we know what it is, has it a prayer of doing so when the goal is assessing the future?”
Why does this happen?
I have tried explaining this in detail in a past article, which you can read here.
In summary, markets are driven by mass sentiment. When mass sentiment changes direction, the most immediate effect is investor buying and selling of stocks. That is why everyone recognizes the stock market as a “leading indicator” for the economy. But it is not due to some form of omniscience. Rather, the most immediate manner in which investors can act upon their changing sentiment is by buying and selling stocks.
However, the fundamentals will significantly lag this effect. You see, it takes a lot of time between a changing sentiment and the point at which the delayed data begin to filter into economists’ reports. In fact, it can be so delayed that by the time they have recognized that we are in a recession, we may be near its completion.
This explains why economists are often the last to be able to prognosticate a downturn in the economy well before it happens. This is even more true for their ability to predict a decline in the stock market. Moreover, as Douglas put it, they are often most bullish at the highs, and most bearish at the lows.
So when one of my members reports that two of 150 leading economists see any potential for a recession, that is something you should take note of.
Allow me to give you a few more examples of economists who are — and were — certain of their economic perspectives.
Recently, Larry Kudlow, the director of the National Economic Council, boldly exclaimed that “recession is so far in the distance, I can’t see it.” Mind you, Kudlow made that statement just as the stock market began its descent.
Before Janet Yellen stepped down as the chairwoman of the Federal Reserve, she said the banking system is “very much stronger” due to Fed supervision and higher capital levels required by banks. She then predicted that because of the measures the Fed has taken, another financial crisis is unlikely “in our lifetime.”
That sort of perspective is akin to the following: “We will not have any more crashes in our time.”
This was said by John Maynard Keynes in 1927, two years before the stock market crash that led to the Great Depression.
“Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon, if ever, of a 50- or 60-point break from present levels, such as they have predicted. I expect to see the stock market a good deal higher within a few months.”
This was said on Oct. 17, 1929, a few weeks before the aforementioned crash, by Irving Fisher, professor of economics at Yale University. Fisher was one of the leading U.S. economists of his time.
• “I cannot help but raise a dissenting voice to statements that we are living in a fool’s paradise, and that prosperity in this country must necessarily diminish and recede in the near future.”
— E.H.H. Simmons, president, New York Stock Exchange, Jan. 12, 1928
• “There will be no interruption of our permanent prosperity.”
— Myron E. Forbes, president, Pierce Arrow Motor Car Co., Jan. 12, 1928
And those are just a few of the popular quotes of their day. And, by the way, has anyone heard of the Pierce Arrow Motor Car Co.? No? That’s because the company went bankrupt during the Great Depression. But I digress.
Learning from history
As George Santayana wisely said: “Those who do not remember the past are condemned to repeat it.” And, as Douglas highlighted, economists have never learned from history.