On Thursday, the Massachusetts unemployment rate dropped to 2.9%, which is the lowest level since January 2001. The Dow Jones Industrial Average is flirting with going over 20,000, inflation is picking up, interest rates are rising, property prices are near highs, and commodity prices are jumping. We have entered the late upswing stage of the economic cycle. The recovery stage was between 2009-2011, and the early upswing stage occurred between 2012-2015.
The late upswing stage will end when bond yields stop rising, the stock market starts falling, home prices fall, and consumer confidence drops. The different stages of the economic cycle tend to be gradual and go on longer than people expect.
A good example to show how long economic stages can last is the case of the stubborn property seller. The level of housing supply is still tight and there are more people shopping for a home. As interest rates rise, monthly payments will also rise. Higher mortgage rates will result in many new home buyers unable to afford overvalued prices. It’s the affordability or monthly payment that matters the most. As interest rates rise, houses will sit on the market longer until sellers adjust their prices lower. It can take 12-18 months before the seller begins to adjust their prices lower. If we enter the recession stage, when job losses are high, home prices can drop dramatically. As we all know, the housing crash in 2008 was only so damaging because prices became overvalued.
Over the next few years, I expect higher market swings, because our President-elect wants to add more stimulus during the late upswing stage of the economic cycle. Cutting taxes, rolling back regulations, creating jobs, and adding infrastructure normally occurs in the early recovery stage. The result of this mistimed stimulus will be higher inflation, record breaking corporate profits, rising wage growth, and higher interest rates.
My favorite economist is David Rosenberg, and he appeared on CNBC with a warning about the extreme values in stock prices. His market worries include the strong dollar crimping profits, mortgage rates rising, and overblown expectations that Trump can achieve all of his ambitious goals. In his view, markets are pricing in above average earnings growth next year, and market sentiment is too high. In 2017, he expects more acute volatility with wider price fluctuations. In his words, active management should “trump” a more passive approach. I agree with his sentiment that to be profitable in 2017, you should be willing to trade the market a lot more than you have in the past.
Since the election, the trading for all of my clients has picked up, as I have taken advantage of new opportunities. The small trading costs have been worth the higher gains in portfolios over the past few months. My belief is that the late upswing stage will go on longer than people expect, but it will be a bumpy ride. The recession stage could come sooner than expected if President elect-Trump upsets trading partners, or if he fails to meet his own very high expectations.
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