Dear Clients and Friends,
We are all familiar with the story of Goldilocks and the Three Bears, and the story has absolutely nothing to do with the stock market or the economy. Yet, that didn’t stop David Shulman in 1992 from publishing an article describing an economy where inflation was cool enough for the Fed, but warm enough for growth – and the “Goldilocks economy” was born. Shulman happened to be on to something because the economy and market had an amazing run after his article. Over the next 3 decades this term was used to describe multiple time periods where the economy [like porridge] was not too hot and not too cold, leading to strong gains for investors. It would be difficult to describe today’s economy as “Goldilocks”, but the market seems to be pricing in something close to that, so there seems to be a disconnect. Let’s see if we can think through the mismatch, and come to some conclusions about what the market may, or may not, be telling us.
I am going to start with the labor market here in the US. The headline numbers have been strong; it seems like every month the economy adds plenty of new jobs. However, if you go back to last year (2023), you will notice that the headline numbers for jobs were inflated, and I mean they were way off, by over 400k jobs. The market knows that during times of economic weakness the numbers from the BLS under-report job losses, as was evidenced in 2008 when the data showed 760k job losses for the 3 quarters of that year, when in fact the number was later revised to 1.64 million job losses*. So downward revisions are likely when we see labor market weakness, and today is no different. But you might argue that today the Fed is trying to cool a hot labor market, so this outcome is desired, and you would be mostly correct. The Fed wants the labor market to cool, but at what cost?
Next, we will look at inflation which has undoubtedly cooled over the last few years, but remains stubbornly elevated for the Fed and consumers. A cooling job market definitely helped cool inflation, but there seems to be a basal level of inflation that is sticky, and may be hard for the Fed to eradicate without doing more damage to the economy. This leads us to the conclusion that the Fed will likely not push rates higher to smash inflation due to the risk of crushing the economy. But will keeping rates higher for longer do more damage to the economy without bringing inflation down? This question should bother any market participant because the signs of distress are evident within the economy, but you can’t really see that by looking at the market.
So why is the market telling us Goldilocks when there are ominous signs of Three Bears? First, inflation works on all assets, the price level of food, services and yes, stocks have all responded to price levels going up. Second, the market has a forward-looking element, and until that perception changes the market stays fixed on its sanguine outlook. Right now, the market is elated about the opportunity in AI, tech and a handful of other growth-related assets, and this is where most of the markets upward mobility is found. Most stocks in our market have not participated in the rally, only a select number of stocks and this should not be considered a ‘healthy market’. The market seems focused on the Fed cutting rates, and assets going higher once this occurs, so participants are trying to front-run this event, which gives the appearance of strength. The set-up is not “Goldilocks” and not “Three Bears”, but rather something close. The market has become Goldilocks for some participants, sampling the bowls of porridge, while others are the Three Bears – which will lead to a reckoning at some point. That reckoning will happen the same way it has happened in the past: with both winners and losers – and those Goldilocks and the Bears may both have their porridge “just right”.
*https://www.investopedia.com/terms/g/goldilockseconomy.asp#:~:text=Economist%20David%20Shulman%20is%20widely,the%20ideal%20economy%20for%20investors.
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