Investors' mood and their outlook on the economy often go hand in hand. In turn, that economic outlook and a glance at the headlines act as a powerful confirmation of their mood. With this feedback loop in place, it is no wonder it's a surprise when the business cycle eventually turns.
The latest headlines have been decidedly upbeat. Nationally, after six years now, recent job growth has pushed the official unemployment rate closer to normal than not. The jobs picture looks much better than it did during the depths of the recession.
With the recent free-fall in oil prices, the typical family is now saving real money at the gas pump. It is providing an especially meaningful boost to those who have fallen behind after years of less-than-inflation wage hikes. Some cite this factor alone as a reason to be more optimistic about economic growth this year.
To add to the sense of optimism, the Federal Reserve is forecasting steady economic progress. They always do, of course. Yet, this time, they appear confident enough to broadcast the start of interest rate hikes later this year. It begs the question, if the Fed believes the coast is clear, why doubt it?
The typical investor feels the economy, as it is now, and they tend to expect more of the same in the future. On the other hand, markets react, ahead of time, through a series of collective guesses about the future. Understandably, this disconnect confuses investors who remain fixated on the last pitch, not the next one.
Here are three educated guesses for the next pitches in 2015.
First, the U.S. economy is not an island. With both Europe and China experiencing an economic slowdown and with Japan seemingly stuck in the doldrums, the U.S. is currently viewed as the cleanest shirt in the dirty laundry. Rest assured, we are intimately connected to our major trading partners.
Next, pay attention to the signal of declining interest rates. The decline in longer-term rates in the face of the Fed beginning to hike short-term rates is typically viewed as a leading indicator of a slowdown on the horizon. Like the start of last year, investors once again think rates will rise. With inflation still in decline, I wouldn't bet too heavily on it.
Last, when both spirits and stock prices are high, lean against the crowd. With interest rates this low and with recent returns this good, an understandable — yet dangerous — sense of a permanence of prosperity for stock market investors is forming. There will come a time when caution once again equals wisdom.
Jason P. Tank, CFA is the owner of Front Street Wealth Management, a fee-only wealth advisory firm located in Traverse City. He encourages questions and comments about future columns. Contact him at (231) 947-3775, by email at Jason@FrontStreet.com and at www.FrontStreet.com.