Why 2018 is Different from 2008
A spike in wage growth in February sparked concerns over rising inflation that caused the first market correction in two years, and raised concerns that the next bear market environment for stocks was upon us. In our last article this past December, we addressed how bear markets (i.e. decline of 20% or more) tend to be caused by economic recessions, and provided reasons as to why we believe the probability of recession is low for 2018. This remains our central case scenario, despite the increased levels of volatility and rising inflationary data we have experienced this year. Furthermore, in conjunction with economic recession, you typically need other conditions to cause a bear market, which can include excessive valuations and/or tighter monetary policy.
We recently ran across an interesting research report from a global asset manager that provides more clarity as to the differences in today’s market and economic climate versus the last bear market environment back in 2008. Corporate and household balance sheets are much stronger today, with greater cash levels and less leverage than the years leading up to 2008. Asset valuations today are nowhere near excessive levels, which typically lead to bursting of bubbles (i.e. tech bubble of early 2000s and housing bubble of mid 2000s). Today, rising home prices have not hit levels we saw back before 2008, as home prices have appreciated by an average of 5% nationally over the past four years versus the 10%+ appreciation we experienced prior to 2008. Stock valuations, despite being slightly above long-term averages, are nowhere near their historical highs as well.
Furthermore, economic and earnings growth slowed into 2007, which indicated a recession was potentially on the horizon. Today, both U.S. and Global economic growth has been accelerating thanks to strong labor market, with lower tax rates supporting increased consumer and business spending to further spur economic growth. The recent labor market report detailed the continued strength, as payrolls surged by 313,000 jobs created in February and the unemployment rate held at a 4.1%. Wage growth fell slightly for the month, which may alleviate fears over rising inflation. In fact, inflation has averaged under 2% over the past several years, whereas it was approaching 3% heading into 2008. Furthermore, despite five rate hikes since the Federal Reserve began raising their benchmark rate in December 2015, the current rate remains nearly 4% below the peak prior to 2008.
Still, there are potential shocks that could potentially cause the first bear market in nearly ten years. The biggest risk centers around President Trump’s recent declaration of tariffs being placed on aluminum and steel made outside of the U.S. This has increased rhetoric from our trading partners in Europe and Asia that they may place tariffs on goods made here in the U.S., bringing about a “trade war”. This has major negative economic implications, although the White House has since announced countries may apply for exemptions which dampens some of the concern. We believe the probability of an all-out trade war is low, but the headline risk may create periods of volatility over the course of the year. Despite the higher level of volatility, we believe the current climate should help stock markets appreciate over the year. However, investors should make sure they maintain the appropriate allocation between stocks and bonds to help manage risk in their portfolios.