Which Way Do We Go From Here?

Dorothy: Now which way do we go?
Scarecrow: Pardon me. That way is a very nice way...[pointing]
Dorothy: Who said that?
[Toto barks at the Scarecrow]
Dorothy: Don't be silly, Toto. Scarecrows don't talk!
Scarecrow: It's pleasant down that way too!...[pointing in another direction]
Dorothy: That's funny. Wasn't he pointing the other way?
Scarecrow: Of course, people do go both ways. [pointing in both directions] That's the trouble. I can't make up my mind. I haven't got a brain. Only straw.
Dorothy: How can you talk if you haven't got a brain?
The Scarecrow: I don't know. But some people without brains do an awful lot of talking, don't they?
Dorothy: Yes, I guess you're right.

Dorothy and the Scarecrow, The Wizard of Oz, 1939

One the reasons The Wizard of Oz is such a great movie (and a wonderful book, too) is that it contains so many parallels to the markets and economics, and to life in general. Some have even said it was written as an allegory about the state of the country in the 30's following the stock market crash and Great Depression.

I couldn't help thinking of this exchange between Dorothy and the Scarecrow while reading through recent work from the President's Council of Economic Advisers.

Among other things, the Council, a group appointed by and working for the President, is charged with crafting the annual Economic Report of the President, a 599-page tome for 2017 summarizing the past year in the economy, a variety economic, political and legacy issues as seen by the Executive Branch, and the government's outlook. There are three members on the Council, each with PhD's in economics (two from Harvard, one Berkeley), and their various staff members. A lot of brain power goes into crafting reports like this. And as you might expect, the report is pretty positive and reads a bit like an economic swan song. We have come a long way since the Great Recession that welcomed the Obama Administration.

But with all the data and analysis in the report, it's important to remember just how challenging it is to put your finger on the direction of the economy at any moment in time. It's much easier to read as history instead of as current events. With a population of around 320 million and half of those in the labor force, ours is an incredibly large and complex economy. The typical question of "How's the economy doing?" does not have a simple, honest, answer on any given day. It's nuanced and subject to interpretation. The Scarecrow could have been an economist.

On an ongoing basis, investors, business owners, academics, politicians, etc, follow many different indicators to try and gauge the health and direction of the economy. The Conference Board, a non-governmental organization, publishes a standard set of indicators, broken down into different categories: leading, lagging, and coincident.

Here are the Conference Board's Leading Indicators:

• Average hours worked in the manufacturing sector
• Weekly claims for unemployment insurance
• New orders for consumer goods and materials
• Delivery time of materials, etc, to industrial companies
• New orders of non-defense capital goods
• The level of the S&P 500 stock index
• Consumer Expectations
• Building permits
• Money Supply
• The Yield Curve (direction of short, medium and long-term interest rates)

Here are the Lagging Indicators:

• Average length of unemployment
• Value of commercial and industrial loans
• Changes in the Consumer Price Index
• Changes in labor costs
• Manufacturer's Inventory
• Consumer credit levels compared with income
• The Prime Rate charged by banks

The leading and lagging indicators probably sound intuitive. As you might expect, leading indicators should predict the direction of the economy maybe 9-12 months out. Lagging indicators well, lag, or follow the economy, telling you what has already happened, sometime years afterward.

Coincident indicators, on the other hand, are of the "what's happening right now, and what direction are we headed in" variety, and there are many. But economists and analysts of various types do not always agree on which indicators are the most important, or even which are the most accurate. Some are subject to large revisions and none are useful on their own. President Truman once quipped that he only wanted one-armed economists, because his advisers kept saying, "but on the other hand...". If you start following this stuff closely you'll quickly sympathize with Truman.

So how's the economy doing right now? At this point most of the leading indicators are pointing in a positive direction. In hindsight there was a positive shift in the economy during the middle of last year. This shift, and the recent surge in some of the indicators following the election, have economists and analysts revising their growth projections upward. The International Monetary Fund, for example, just raised its outlook for the U.S. economy, even after accounting for added risk associated with a Trump Administration and a "hard" Brexit.

It may turn out that growth accelerates and we enter a new phase of optimism and opportunity. But on the other hand... in all seriousness, I think it's best to be prudent, focus on asset allocation and rebalancing, and stay disciplined as we move forward from here.

If you're interested, here's a link to a summary of the report I mentioned:

https://www.whitehouse.gov/blog/2016/12/15/2017-economic-report-president

Have questions? Ask me. I can help.