Irrational Optimism

In the months following the election, we saw optimism surge higher in a number of prominent indicators…

  • Homebuilder sentiment hit an 11-year high.
  • Small Business optimism hit a 12-year high.
  • Consumer confidence hit a 13-year high.
  • Philadelphia Fed Manufacturing survey hit a 33-year high.

The thinking was as follows: a new era of higher economic growth was about to take hold, driven by lower taxes, deregulation and massive infrastructure spending. It was said that 5% real GDP, a stronger U.S. dollar, higher long-term interest rates, and higher wage growth were coming.

Reinforcing this belief was the booming stock market in the U.S., hitting new all-time highs on a daily basis and doing so with just about the lowest volatility in history.

Fast forward to today and the stock market continues to hit all-time highs with record-low volatility, but something interesting is developing with respect to the aforementioned levels of optimism. They are starting to move back down…

  • Homebuilder sentiment has moved down to its lowest level since last November.

Image of Housing Market Index

  • Small Business optimism has moved down to its lowest level since last November.

Image of Small Business optimism index

  • Consumer Confidence has moved down to its lowest level since last October.

Image of Consumer Confidence as per University of Michigann

  • Philly Fed Manufacturing Survey has moved down to its lowest level since last November.

Results of Philly Fed Manufacturing Business Outlook Survey from 1968 to 2017

But these are just surveys. Perhaps the real economic data is painting a different picture.

Let’s take a look…

  • In the first quarter, Real GDP came in at 1.4%. In the second quarter, the Atlanta Fed is projecting 2.5%. The average of the two, 1.95%, is below the expansion average of 2.2%.
  • In the first six months of the year, the U.S. added an average of 180,000 jobs per month. In the prior five years, the U.S. added an average of 214,000 jobs per month.
  • In the first six months of the year, U.S. Retail Sales rose at an average pace of .07% per month. Over the prior five years, the average rate of growth was 0.29% per month.
  • In the first five months of the year, Real Personal Income grew at an annualized rate or 1.89% per year. Over the prior five years, it grew at an average rate of 2.28%.

Based on the data, it would be hard to argue that economic growth is improving, and certainly not supporting the belief that 5% real growth is attainable anytime soon. If anything, growth appears to be slowing down just a bit.

Meanwhile, the U.S. Dollar Index is at a 52-week low, down against every major currency in 2017.

Graph showing U.S. Dollar Index at a 52-week low, down against every major currency in 2017

And long-term bond yield have fallen in 2017 while the yield curve (10-year minus 3-month yields) is close to its flattest level of the expansion. The bond market certainly is not buying into a move to 3% real growth, let alone 5%.

Comparison of US yield curve, US 10 year treasury yield and US 3 month treasury yield

But we still have the stock market, hitting new all-time highs on a daily basis with no volatility to speak of. In contrast to the economic surveys, sentiment there has certainly not waned. Is this a signal that 5% growth may indeed be coming? Only if you believe the stock market is the economy.

In recent weeks, the President has suggested as much. Mr. Trump, who called the entire stock market advance under President Obama a “big, fat, ugly, bubble,” has been touting it as a barometer of success…

Stock market tweets by Donald Trump in the month of July

It would be an understatement to say that there has been no President in history who has mentioned the stock market with greater frequency. This is interesting, for if the stock market is said to be a real-time reflection of his performance, what will the President say when it actually goes down (there hasn’t been a 5% correction since he was elected, one of the longest stretches in history)?

As most market participants understand, the President and their policies have very little influence on equity returns. There are a multitude of factors that drive the stock market (earnings, valuation, sentiment, economy, etc.), and the President is just one microscopic piece of that puzzle. This is as it should be in a free market economy, where no one person has undue influence.

Considering the growing divide between the stock market and the real economy, the question for investors is whether they still believe the post-election narrative to be true. Will the dream of 5% growth be realized and do they take Trump at his word when he says: “we’ve signed more bills – and I’m talking about through the legislature – than any President, ever”?

Rational optimism is the best default mindset to have in the long run. Put simply, things tend to get better over time. But there are times in the short run when optimism can reach a level that is simply not supported by the data, hence becoming irrational. After the election, the homebuilder/consumer/housing/manufacturing surveys were at such a point. In recent months they seem to be slowly coming back to reality, understanding that there was no paradigm shift on election day.

Will the stock market be next?


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This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. It also does not offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.



Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors. He previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University. He has also done a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.


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