PANC 2016: Painting by Numbers

J.P. Morgan lead economist David Kelly, officially the firm’s chief global market strategist and head of the global market insight strategy team, opened the 2016 PLANADVISER National Conference with an in-depth look at the last year in macroeconomics; from China uncertainty to Brexit to deep demographic shifts, there’s a lot for advisers to consider on the road ahead.  

Giving attending advisers a bit of a history lesson, Kelly observed that the S&P 500 has had an impressively volatile ride in the last two decades, with the latest bull run pushing the price index well above 2,000. Right now price-to-earnings ratios may seem high, at roughly 16.6-times earnings against at 15-year average of 15.9-times, but historically this is actually a pretty modest price premium to own the market, he said.

“Prior to the market disruption in early 2000, P/E ratios in the S&P 500 had climbed higher than 24-times earnings,” Kelly observed. “Granted, P/E ratios have been on the rise since reaching a very low base in the wake of the financial crisis of 2008, when they had dropped for a short spell below 10-times earnings. But all indications are that the markets are much healthier today and that this bull market has more room to run.”

What is worrisome, of course, is that even informative metrics like P/E ratios are far from perfect, Kelly said. Notably, there was little indication in P/E data of trouble prior to the 2008/09 financial crisis. In fact, P/E ratios were lower then than they are today. The absolute level of corporate earnings per share was significantly lower from 2006 into the crisis, however.

“Where are we right now according to the numbers? What does it all means for clients?” Kelly asked. “These are the big questions we are all concerned with, and I think the answer will surprise a lot of people. According to Americans you poll on the street, things are tough, but based on the real numbers we are actually looking pretty darn rosy.”

As examples of positive data points, Kelly cited the unemployment rate below 5%, mortgage rates below 3%, low gas prices, and inflation below 2%. “And we’ve had just a single recession in the last 14 years. It’s really not that bad at all according to the numbers.”

NEXT: Looking at the American Economy 

Kelly said he is perfectly aware that, in the investment domain, it’s “often far more important how things appear rather than how they actually are.” And there’s no denying that the top-line numbers miss the financial uncertainty that continues to plague many Americans even now, years after the financial crisis. Kelly tied much of this sentiment to rising income inequality but also to the more fundamental changes in life and society occurring all around us, from the rise in technology to the fall of the defined benefit pension system.

“It’s the same case in presidential politics—what matters is how it feels and not necessarily what the data tells you,” Kelly explained. “I’m not much of an artist, so I tend to paint by numbers. Looking at it this way the numbers are pretty good.”

Looking at American economy, Kelly continued to hammer on this theme, at least as it applies to the short term. Longer-term demographic worries about labor supply and demand aside, Kelly said the U.S. bull market is “much more of a healthy tortoise rather than a sickly hare.”

“We are in the eighth year of economic expansion and despite that fantastic run, all the data really suggests that we can keep going,” Kelly noted. “I don’t have to tell anyone here that on the fixed-income side things are absolutely brutal right now, so that’s a separate and difficult part of this discussion. Yields are extraordinarily low but there are some opportunities.”

Kelly warned in no uncertain terms that “clients will be hurt if they search thoughtlessly for yield in this environment.” He even went so far as to predict that today’s and tomorrow’s retirees, unless major change comes down in terms of both demographics and the behavior of central banks, will begin to turn away from the traditional 60/40 thinking about the role of equities and fixed-income.

“It’s an unfortunate metaphor but the bond market yield curve is like a prisoner being interrogated right now,” Kelly explained. “I believe that if you push people too hard, they are going to lie to you. Well in a sense the bond yield curve is undergoing this experience right now. All the massive global stimulus has meant that the yield curve is no longer informative, it is no longer connected necessarily to the fundamental economic reality. And so, you have to look at real corporate data and consumer spending performance, and both of those are pretty strong right now. Consumer fundamentals are looking good, as well.”

The lesson, Kelly said, is that until the paradigm of global central bank stimulus goes away, retirement investors will struggle mightily with generating real returns on the fixed-income side.  

“What’s the solution right now? It has to be utilizing a portfolio that is fully globally invested,” Kelly concluded. “People don’t need yield, they need income. It’s about setting up an appropriate risk-return portfolio and then setting up a reliable income stream from that.”