One of Commonwealth’s affiliated advisors, Tom Hine, sent in a question, basically asking, How does now compare with 2007? To quote him directly: “Many of us who are long-term optimists like myself need a dose of reality, because back in 2007/2008 many people felt the same way—yet clearly there were some flashing yellow lights!”
I couldn’t agree more. As I’ve written before, we tend to forget what actually happened very quickly, overweighting more recent experience simply because we remember it better. With that said, let’s look first at the real economy and then at the financial markets.
The peak total employment level, in January 2008, was 138,056,000; as of October 2013, we’re at 136,765,000, for a loss of 1,288,000 jobs. Worse, the population has increased since then, so the ratio of jobs to population is down.
In 2007 and early 2008, however, as you can see, employment was in the process of rolling over. We see no signs of that at present, and the trend is actually for accelerating growth in labor demand and hiring. So, at this point, it appears we’re in a better position than we were. Score one for the good guys.
Debt and Debt Service
Consumer demand drives more than 70 percent of the economy, and excessive indebtedness was one of the things that led to the crisis in 2008. Where are we with consumer debt?
As the chart shows, consumer credit as a percentage of GDP has largely recovered to 2007 levels and is consistent with levels of 2000, which is a bit concerning. Looking at debt service, though, we see that, due to low interest rates, the actual financial payment burden is much less. Again, advantage now.
We’re in better shape here than in the past 20 years. This is a good sign, but it depends on low interest rates, which is something to keep an eye on.
The key to housing market activity is affordability. If buyers can afford to buy, you have a vibrant market and price appreciation.
Despite appreciation, housing remains more affordable than at any time prior to 2009. Again, score one for now. But, as with the very positive debt service figures, this depends on low interest rates, and so bears watching.
For the real economy as a whole, we appear to be in a much more solid position than we were in 2007. As I’ve repeatedly mentioned, though, the real economy and the financial economy work on separate schedules, so that doesn’t necessarily mean the financial economy is also better positioned.
Stock Market Valuations
Stock market valuations, based on forward earnings expectations, were at around 15x in 2007, and right now they’re also around 15x.
As we are bouncing around the 2007 highs on a valuation basis, it suggests that the positions are similar—something to worry about.
Stock Market Debt
The debit balances at broker/dealers are now at levels above those of 2007. As you can see from the chart above, we also saw a peak in 2000. Overall, this is a worrisome metric.
This chart, from the American Association of Individual Investors, shows the percentage of investors who are bullish. You can see the clear correlation of peaks (1987, 2000) with subsequent crashes, but other peaks (2004, 2010) don’t show that association. Right now, bullishness is reasonably in line with 2007, so no score either way.
Comparing today with 2007, the real economy seems to be in much better condition now than it was then. Employment is trending better, household debt has normalized and debt service is very low, and housing remains very affordable. The real economy appears likely to continue to grow.
The stock markets are more mixed. Many signals—valuation levels and underlying debt—are at or above 2007 levels. Just as the real economy suggests better performance than 2007, the stock market indicators suggest similar performance to 2007, which isn’t a good thing.
If we had been doing this exercise in 2007 (comparing it with 1999, say), we would have concluded that the real economy was overextended, which proved to be the case. We also would have seen that the markets shared many characteristics with those of 1999. Had we done that—and listened—we might have been better prepared than we were. This time, while the economic conclusion is better, the stock market conclusion is also worrisome. Perhaps we should pay some attention this time.