Opinion: The economy is in much better shape than the headlines suggest

Inflation is through the roof.

There is an oil crisis. A looming food crisis. They call it.

War is raging in Europe.

Russia’s president is beginning to get out of joint. And the headlines now link him to chemical weapons and nuclear weapons.

Ohmyhgaad- Ohmyhgaad- Ohmyhgaad!

Things are so bad that stories that would normally make headlines – like waves of Covid cases and deaths, China locking down cities and North Korea firing long-range missiles – barely get a mention.

nuclear weapons?

No wonder stocks have fallen this year.

US consumer confidence is at a low seen only during the global financial crisis and crises of the 1970s. Indicators like the American Association of Individual Investors’ weekly sentiment poll and the CNN Fear & Greed Index show investors are in extreme misery.

If you’re tempted to cash out the stock funds in your IRAs and 401(k)s and hide under your desk, you’re not alone.

But before you do that… listen to Jim Paulsen.

He is the chief investment strategist for Leuthold Group, a Midwest money management firm. And he recently gave a presentation to clients that could have been called, apologies to the late Ian Dury, “reasons to celebrate”.

In short, Paulsen argues: Things aren’t as bad as you think. He believes the economy is in much better shape than the headlines suggest. The stock market will trend back up sooner rather than later. Oh yes, and that there are good profit opportunities for every single investor.

Take it or leave it, but Leuthold is no ordinary Wall Street bookie. The Midwest company is a pretty skeptical, down-to-earth place. It even operates a “Grizzly Short Fund” that bets on falling stock prices. They’re not usually mindless cheerleaders.

What is Paulsen’s case? Here are his 3 main reasons to look on the bright side.

Everything opens again

The big news of the moment, largely forgotten in the current panic out of Eastern Europe, is that the pandemic is over. Policymakers and even the media have finally accepted that Covid is not going away but must be managed: it will be ‘endemic’ rather than a pandemic. Net result: The world opens up again. Business starts again. People will travel. They go shopping. They will go to restaurants.

Oh, and most importantly, stores need to restock their empty shelves after two years of supply chain crisis. Inventories are at an all-time low compared to gross domestic product, he says. Corporate backlogs are near 30-year highs. In addition, he adds, consumers are sitting on about $1.5 trillion in additional savings because they’ve spent less over the past two years.

While the Atlanta Federal Reserve’s real-time GDP tracker is showing a slowdown in first-quarter growth, Paulsen points out that the Citi US Economic Surprise Index is rocketing higher. And it leads where GDP follows. Meanwhile, corporate earnings look extremely healthy and estimates have been revised upwards since the beginning of the year.

As for the humanitarian catastrophe unfolding in Ukraine as a result of the Russian invasion, the real impact on the US economy will likely be less than headlines suggest and will be temporary, argues Paulsen. And that’s true regardless of whether the war ends soon (we hope) or turns into a protracted standoff.

Jobs! Jobs! Jobs!

The US economy added 1.2 million jobs in the first two months of this year alone – an impressive feat achieved despite the ongoing strain from the Omicron Covid outbreak. There’s still plenty of room to grow. We are still more than 2 million jobs below the pre-Covid peak, and Paulsen notes that the labor market has risen to new highs after every recession since World War II – often well above the previous peak.

Figures from the US Department of Labor suggest the economy could add an additional 7 million jobs just to reconnect with the growth trend seen just before the pandemic. Paulsen points out that unemployment rates have fallen sharply in the 44 states with the smallest economies, but not yet in the “Big Six” that actually contain the most jobs – namely California, New York, Texas, Illinois, Florida and Pennsylvania .

Meanwhile, wages are booming. The Atlanta Federal Reserve’s proprietary “wage tracker” shows annual wage inflation skyrocketing to 5.8% – the highest since at least the 1990s. But, as Paulsen points out, most of that wage growth is accruing to the low-skilled and low-wage earners, who are finally getting (slightly) better wages. So we’re hiring millions more people, and they have a lot more money to spend — especially those who are most likely to spend.

Inflation?

That brings us to the £800 cliche in the room, which is inflation. This is the current source of the panic and there is much talk of 1970’s style ‘stagflation’. The official inflation rate hit a staggering 7.9% in February, the highest in decades. Federal Reserve Chair Jerome Powell is officially alarmed and has stopped saying it is “temporary”. Paulsen says it’s probably the biggest risk right now. Unless the Fed cuts inflation, he says, the recovery will be over pretty quickly.

But…well, as Paulsen puts it, “the inflationary hysteria is everywhere — except in the financial markets.” Despite all the panic headlines, the bond market is not worried about inflation. Neither does the stock market or the foreign exchange markets.

For example, in the 1970s, when inflation hit 6%, the bond market responded by demanding an 8% yield on 10-year US Treasuries to reflect the risks. Today, that yield is less than 2.5%. In the 1970s, rising inflation crashed stocks. There was a fix this time, but so far it’s been reasonably modest. Oh, and in the 1970’s, rising inflation pushed the US dollar into the foreign exchange markets. This time the dollar is rising.

The Atlanta Fed says current inflation is mostly found in things with highly flexible prices like cars, fuel, clothes and groceries. These prices can go down as fast as they go up. The inflation rate for “sticky” items like rent or medical supplies, where prices tend to stagnate once they rise, is barely 4%, it said. Meanwhile, the San Francisco Fed calculates that most of the current inflation is due to reopening and supply chain issues after the two-year crisis.

The key inflation metric to watch is what’s known as the five-year “break-even rate” for US bonds, a technical metric that effectively represents the bond market’s own five-year inflation forecast. And it’s up — it’s been up for over a year — but it’s still at 3.57%, or less than half the current rate of inflation. In other words, the bond market is still predicting that inflation will halve from these levels, and relatively quickly. If you know something the bond market doesn’t, get out there and make yourself rich.

Reasons to be Bullish? Maybe, maybe not. However, with sentiment already near maximum gloominess, logic suggests that the next move will be up rather than down.