RCM Managed Asset Portfolio - Q2 2021

RCM Managed Asset Portfolio

By Christopher Chiu, CFA

Some Observations about the Current Economic Recovery

Many of you will see that your portfolios have done well over the past quarter. In the actively managed equity programs we did some rebalancing. We took some gains in some commodity and cyclical names such as Nucor, Chevron, Boeing, and the energy ETF XLE. Some of these positions had 50-100% returns since we bought them last Spring. But as their name implies cyclicals also have bad times. And we didn’t want to be in a position where we gave up everything we made if the good times changed to bad. But if the good times continue for commodities, we still have an allocation that will benefit.

In past letters I have used charts containing economic data to highlight where we were in the economic cycle and why we positioned the portfolios in the way that we did. In this letter I wanted to go through some of these same charts to show where we are in the economic cycle now and how long this bull market might continue. We are currently in the midst of an economic recovery. But we are no longer at the very beginning stages of this recovery. In many ways we are farther along than many might think.

One chart I have often used to gauge where we are in the economic recovery is the chart showing unemployment claims. My argument has always been that at the end of an economic cycle when unemployment gets too low, there is no more available labor to continue growth in GDP and that is when the equity market becomes vulnerable. Currently we are neither at the end of the cycle or at the very beginning. Instead, if you are looking only at unemployment claims, we are at the same point we were at in 2012-13.

So even though we are a little more than a year into this economic cycle, if you were to gauge the economic recovery in terms of unemployment claims, we are much farther into the economic recovery than many might think.

That conclusion is also consistent with this chart which shows the number of new single family homes for sale. During the last economic cycle we reached a bottom in August 2012. At present, we seem to have already reached a bottom and have begun to turn up.

The tenor of these data is well worth monitoring. When we should become wary is when we get up to the 400,000 area of new single family home sales. In past eras when we exceeded 400,000 single family homes for sale, we have generally peaked as an economy. We are at least a couple of years from that level now. And as it now stands there is a lack of housing in many areas of the US, so we can probably stand to go higher than 400,000 new units per year.

Here is another chart showing we are farther along in recovery than many may believe. Currently the number of heavy weight trucks being sold is what you would typically see in a mid to late cycle.

This last chart in particular does not mean we are fated to go into recession anytime soon but it does mean, many parts of the economy are very healthy and are well advanced into their recovery.

However, there are also data that run counter to the idea that the recovery is very far along. The growth of bank loans took a slight dip recently, during which time it moved from positive to negative territory.

Note the loan growth in other expansionary periods. It is consistently positive for many consecutive years. We would want to see consistent positive loan growth for a prolonged period to say the recovery is on a sustaining path. And we probably aren’t there yet in the banking sector.

Conclusion

This bull market may not last as long as the last one. The main issue is that when compared to the financial crisis in 2008, this time around the Fed didn’t allow the downturn to endure that long and become as severe. As a result, the current economic recovery doesn’t require as long a runway to reach full capacity again. That shortened time period also leaves a shorter runway for equities to continue to gain value. Having such a great year in equities last year, it makes sense that there could be a period of sideways action before another leg higher.

This does not mean conditions have become unfavorable for stocks. Conditions remain very good. Just keep in mind that investing in stocks and bonds is a long-term endeavor.