As if the headlines out of Europe weren't bad enough, the latest domestic business headline read Service Sector Grows at Slowest Pace in Two Years:
The service sector in June grew at the slowest pace in nearly two and a half years, more evidence that the economy has weakened. The Institute for Supply Management said Thursday that its index of nonmanufacturing activity fell to 52.1 last month, from a May reading of 53.7.
The reading was the lowest since January 2010. Still, any reading above 50 indicates expansion. The sector has grown now for 30 straight months
It's headlines like these that have the average investor wondering if they should still believe in a bullish future for US equities.
The Tipping Point Effect
Despite the fact that we've seen 30 months of expansion -- granted, not the best expansion, but not doomsday either -- the market is still priced for utter disaster. The flight to Treasuries has driven yields down to levels not seen since the fallout of the 2008 financial crash:
click to enlarge
Why is this? And why is hiring so slow, even though the consistent Doomsday predictions aren't panning out?
I believe the answer lies in the premise of Malcolm Gladwell's The Tipping Point. (Great book, I recommend it.) The author describes the "tipping point" as the "magic moment when an idea, trend, or social behavior crosses a threshold, tips, and spreads like wildfire." Apple had a tipping point where it went from niche to trendy. And while the US economy is undergoing a slow but steady recovery, hiring is still slow because it hasn't hit its tipping point yet.
The Uncertainty Cycle
The keyword for hiring is "uncertainty." A lot of employers, especially small businesses, are reluctant to hire because of uncertainty about the recovery and the government:
When asked what is holding them back, uncertainty was the most common explanation. Fifty-two percent of those surveyed said they were not hiring because they weren't confident in the recovery, with another 33 percent pointed to uncertainty driven by Washington.
I've previously analyzed this phenomenon in my Hook 'em Horns article. Even large S&P 500 companies sitting on cash piles have been slow to hire, because the whole thing is essentially one giant vicious feedback cycle. The end retailer doesn't hire because they don't want to train employees only to have to let them go because there isn't enough demand. Consequently, their supplier doesn't want to hire because THEY'RE now afraid there won't be enough demand -- and this effect continues on up the supply chain. It's a catch-22/chicken-and-egg argument: I won't hire because you won't hire. (The ACA ruling obviously won't help.)
Get Ready for a Ride
The thing with feedback cycles like the one we're in is that once you get that little push and get over the tipping point, things either go really right or really wrong, depending which side you're on. My argument is that we're near a "good" tipping point, and we could be pushed over the edge by any one of the following:
- Seriously positive news out of Europe
- a Romney victory in November
- Emerging markets recovering and boosting exports
- Surprise positive economic data (job reports, etc)
- Overwhelmingly strong Q2 earnings reports
Since the market is already priced for defeat (see Treasury yields, P/E ratios, Wall Street equity allocations, etc), positive news to break the status quo chain could spur a flurry of confidence in the market and in small businesses -- which in turn would create even more confidence, etc.
We're already starting to see positive signs. I'm increasing my equity allocation in anticipation of the tipping point in hiring -- and the markets.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
