By Mark Hulbert
The economic risk in the USA is actually average
The economic risk is currently only average. I point out to counter the many stock market analysts who have warned in their 2024 forecasts that the current risk level of the US economy must be at or near a record high.
And many of you are convinced that you are right.
It is well known how analysts recite the current risks: the war in the Middle East could escalate into World War III. The war in Ukraine could also get out of control. Then there is the possibility of higher inflation and higher interest rates in the US, as well as a possible recession. The list goes on.
The problem with this narrative is that the risk is not always high. Our psyche plays tricks on us to make us believe that the risks we are currently facing are spiraling out of control. Because as soon as we know how things turn out, we immediately rewrite history to tell ourselves that it was obvious that they would turn out the way they did.
Consider the range of possible consequences if the US economy is placed into the functional equivalent of a medically induced coma in the wake of the Covid-19 pandemic. Today we tell ourselves that the federal government and the Federal Reserve would of course respond with massive fiscal and monetary stimulus and that the stock market would of course skyrocket in response. But that was anything but obvious in advance.
We know this because of an objective measure of economic uncertainty created several years ago by finance professors Scott Baker of Northwestern University, Nick Bloom of Stanford University, and Steven Davis of the University of Chicago. Known as the Economic Policy Uncertainty Index, the index is based on monthly searches of ten major U.S. newspapers “for terms related to economic and political uncertainty” (EPU). The attached chart over the last four decades shows that the EPU peak in early 2020 was more than three times the current level.
Furthermore, as you can also see from the chart, the current uncertainty is almost exactly in line with its four-decade average.
Risk compensation
You may find it discouraging that current risk levels, as frightening as they may seem, are merely average. However, remember that risk is essential if the stock market is to produce as impressive returns in the future as it has in the past. Without future risk as high as its historical average, the market's long-term future return would be much lower. So be careful what you wish for (and careful what you complain about).
You may want the market return to be high and the risk to be low, but you can't have both.
Mark Hulbert is a regular contributor to MarketWatch. Its Hulbert Ratings tracks investment newsletters that charge a flat fee to review. He can be reached at [email protected]
More: No interest rate cuts in 2024? Why investors should think about the “unthinkable.”
Also read: Funds are piling into real estate, cash and commodities to protect against a turnaround in interest rates
-Mark Hulbert
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01/20/24 0751ET
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