The Winter of Our Discontent

The Winter of 2015-2016, which came to an end a few weeks ago, has been officially designated as the mildest in the U.S. in 121 years according to NOAA. While this fact will certainly add a major talking point in the global warming debate, it should also be front and center in the current economic discussion. The fact that it isn’t is testament to the blatantly self-serving manner in which economic cheerleaders blame the weather when it’s convenient, but ignore it when it’s not. If economists were consistent (and that’s a colossal “if”), the good weather would be taken as a reason to believe the economy is weaker than is being reported.

The two previous winters were much harsher. 2013-2014 brought the infamous “Polar Vortex,” an unusual descent of frigid polar air that brought temperatures down significantly throughout most of the United States. The next winter was almost as bad, with colder than usual temperatures combined with record snowfalls in much of the country. These conditions were cited again and again by many economists to explain why Q1 GDP growth was so disappointing both years. Annualized growth came in at just -.9% and .6% respectively (Bureau of Economic Analysis). As both 2014 and 2015 got underway, economic optimism had been riding high. When both started off with such resounding stumbles, excuses were needed to explain why the forecasters were so wrong. The snow and cold provided those fig leaves.

Another big difference between this year and the last two is the trajectory of our trade deficits. January and February trade deficits averaged $46.4 billion per month this year. They were just $41.1 billion in 2014, and $41.0 billion in 2015 (U.S. Census Bureau). Trade deficits detract from GDP.

Despite the weather, the inventories, and the trade deficits, very few of the most influential public and private economists have marked down their full year GDP forecasts very much, if at all. Goldman Sachs even believes so strongly in the strength of the recovery that it still expects the Federal Reserve to raise interest rates three more times this year (Wall Street Journal, Min Zeng, 3/31/16).  The IMF just revised down its estimates for 2016 U.S. economic growth, but only by .2% from 2.6% to 2.4%. But if the 1^st quarter matches the Atlanta Fed’s current estimate, GDP growth for the rest of the year will have to average over 3% to achieve that.

This is likely the type of mindless optimism and herd mentality that caused only one in five U.S. large-cap fund managers to beat the S&P 500 in the first quarter. If you have no idea what’s going on economically, you are unlikely to pick the right stocks. High priced hedge fund managers did little better. In fact, the first quarter was the worst quarter for active managers in eighteen years, according to data from Bank of America Merrill Lynch. This tells me that the degree of denial is still very high and that those who resist the stampede may be in a position to realize gains when the likelihood of recession finally becomes apparent to all.

Unlike Goldman Sachs and other big banks, I do not see any more rate hikes in 2016. Instead, I believe that it is far more likely that the Fed will have to roll out more dovish forward guidance until the point where it officially calls off rate increases for the foreseeable future. After that, I believe it will have to take us back to zero percent interest rates, restart quantitative easing, and it may even take interest rates into negative territory. Take your stand accordingly.

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