Leading Economic Index confirms expansion is still underway.
Upper middle class consumers are doing especially well.
Overall economic strength supports the bull market in equities.
The respected Wall Street economist, Ed Yardeni, is famous for his insistence that equity bull markets end only when the economy enters a recession. While there has arguably been at least one notable instance (in 1969-70) of a bear market preceding a recession, this statement has nonetheless held true in the vast majority of cases.
With this as our starting reference, let’s take a look at the major U.S. economic indicators to see if there’s any sign of recession anywhere in sight. As I’ll show here, the bull market remains on a firm foundation due to the strong economic underpinning reflected in the latest data.
Let’s begin this overview of the economy with one of the most historically reliable, and widely watched, of economic indicators. I’m referring to the Conference Board Leading Economic Index, or LEI. Virtually every bear market in equities has been preceded by or accompanied by a downward move in the LEI of at least two quarters (six months) in duration. Although the LEI for the U.S. declined slightly in October, the latest month for which data is available, the index still points to a “slow but expanding economy through early 2020” according to the Conference Board.
Source: Conference Board
The employment outlook has been arguably the most obsessive concern for investors and economists alike in recent years. It’s widely known that the U.S. unemployment rate is near an all-time low, which implies a strong labor market. Yet wage growth has been subdued in the years since the Great Recession and labor force participation has been in decline since peaking in 1999.
There have been many explanations for the phenomenon of declining labor force participation, the biggest one being the supposed mass exodus of Baby Boomers from the work force. Yet there’s no getting around the fact that a downward trend in participation isn’t exactly a ringing endorsement for the strength of the job market. If the job market were truly red hot, there would almost certainly be greater participation – even among Baby Boomer retirees – for a strong job market with rising wages always attracts a steady supply of workers.
Probably the best explanation for the downward trend in the participation rate is the lack of high-paid work opportunities for those with average (or below average) education levels. Highly trained workers of course have no problem obtaining well-paid employment. But when the economy is on fire like it was in the late 1990s, employers experience a chronic shortage of workers due to increasing demand for their products and services. This means they must often lower their employment standards and do on-the-job training just to attract new workers and keep up with rising demand.
We keep hearing employers complaining about a “skills mismatch” when it comes to finding the perfect hire. Business owners, it seems, are unable to find workers with the precise skill set they’re looking for. What it really amounts to, though, is that overall demand isn’t extremely high right now. Otherwise, finding the perfect job candidate with just the right skill set wouldn’t be a top priority; accepting whatever applicants they could get at reasonable wages would instead take precedence. In other words, only when there is slack in the economy can employers afford to be this choosey about who they employ. Thus, while the overall economy is strong, there’s definitely room for additional improvement.
Source: St. Louis Fed
Fortunately, however, the above graph suggests that the labor force participation rate bottomed out in 2015 and is turning around. You can see in this chart the beginnings of a new upward trend that’s trying to get established. Hopefully this trend will accelerate in the coming months and years, for a rising participation rate is one of the best signs that the economy is living up to its full potential.
Now let’s take a look at some of the indicators which I believe offer more of a real-time reflection of the U.S. consumer’s health. While there is definitely room for improvement in the labor market, consumers are nonetheless showing increased confidence in the economic outlook and aren’t afraid to spend. That’s a sign that money is plentiful and job security fears among workers are minimal. While high-paid work may be hard to find right now for the average worker, finding jobs which pay decent wages is no problem.
The idea behind each of the following indicators is that the share prices for the most important companies within the consumer retail and business service sectors can provide insights into the financial health of the consumer. For instance, one way of taking the pulse of the middle-class consumer is to look at the aggregate performance of the leading retail companies which serve that socioeconomic group. I call this, appropriately enough, the Middle Class Index (NYSE:MCI).
The MCI is simply an average of the stock prices of six key companies: J.C. Penney (JC), Ford Motor Co. (F), Dollar General (DG), Wendy’s (WEN), Walmart (WMT), and Kroger (KR). Collectively, these companies are an adequate reflection of whether or not the typical middle-class consumer is spending money. Here’s what the updated MCI looks like as of early November.
Another important consideration in an analysis of the U.S. economy is the upper middle class group of wage earners, i.e. individuals earning well in excess of $100,000/year. This income group tends to be the most lavish spenders when they’re feeling confident about the economic outlook. Conversely, they’re often the first group to reign in their spending at the first sign of economic contraction. When the upper-middle class is in a spending mood, you can be reasonably assured that the U.S. economy is on a sound footing.
Shown below is my Upper Middle Class Index, which includes companies that represent upper-middle income spenders. The components of this index encompass Target (TGT), Starbucks (SBUX), Bavarian Motor Works (OTCPK:BMWYY), Apple (AAPL), and Ruth’s Hospitality Group (RUTH). Here is what this particular index looks like as of early November. As you can see, it’s at a new multi-year high.
One of the components of this index is Bavarian Motor Works (OTCPK:BMWYY), the shares of which have been on an upswing lately (see chart below). Upper middle class consumers have evidently been buying a lot of BMWs this year. According to data released Nov. 1 by BMW of North America, October sales of BMWs increased 9.4 percent on a year-over-year basis. Year-to-date, BMW vehicle sales are up almost 4%.
I regard this as a confirming sign that the broad U.S. economy is still expanding. It certainly isn’t contracting, else the financially prudent upper middle wouldn’t be spending so effusively on luxury autos.
The Upper Middle Class Index is obviously more reflective of upper middle income wage earners. It should therefore come as no surprise that this segment of workers is doing quite well today in terms of income. This explains the increased spending on luxury items. The upper middle class is also more likely than the middle class to be heavily invested in the stock market. For this reason, I consider a rising Upper Middle Class Index to be more important for confirming a bull market in equities than the Middle Class Index. With Upper Middle Class Index at new highs, the bull market in equities is thus still healthy.
A final consideration is my New Economy Index (NASDAQ:NEI). This is my favorite tool for getting a quick read on the U.S. consumer economy. I’ve kept this index since 2007 and it has done an excellent job of tracking the intermediate-term strength or weakness of the retail economy. It’s comprised of the share prices of Amazon (AMZN), eBay (EBAY), FedEx (FDX), Walmart (WMT), and Kforce (KFRC) – the latter being a business staffing and solutions provider and therefore reflective of the job market.
I’ve always believed that the combined stock price performance of these five companies reflect the true underlying health of the broad consumer economy, including the employment outlook. The NEI peaked in August 2018 and hasn’t yet recovered all of its losses. Yet the dominant longer-term trend for this index remains up. Moreover, the NEI has evidently begun a turnaround and appears to be on the upswing once again judging by the recent gains in this index. The turnaround in the beaten-down shares of FDX is one reason for the improvement. It also provides some hope that the outlook for business-related shipping is on the mend after the trade war-related decline earlier this year.
All in all, the data we’ve reviewed here tells us that the U.S. economy is still expanding and isn’t on the verge of recession. The equity bull market which began in 2009 is therefore still supported by the economy’s strength. While there is definitely room for improvement in terms of labor force participation, consumer confidence remains high among middle and upper middle income wage earners. In view of this evidence, investors are justified in maintaining a bullish longer-term stance toward equities.
Disclosure: I am/we are long SPHQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.