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Boring is beautiful


For investors, boring can be beautiful when it comes to economic policy.

That’s what economist James Paulsen suggests in a newsletter for clients of Minneapolis-based Leuthold Group.

“The size, speed and uniqueness of economic policies have been dizzying” in recent years, Paulsen wrote.

He listed several examples, including the Federal Reserve’s treatment of the fed funds rate, which at one time moved in increments of as little as one-eighth of a percentage point.

But when the housing/mortgage collapse occurred in 2007-2008, the Fed slashed the rate from 5.25% to zero in about a year.

The rate plunged again, Paulsen noted, at the outset of the COVID pandemic, dropping from 2.5% to zero in a span of eight months.

This year, it climbed back from zero to 4%, again in a matter of months.    

The fed funds rate is what banks charge each other to hold money overnight. It drives all other interest rates. But it isn’t the only monetary measure that’s become overly fluid. 

Paulson noted that the money-supply growth rate surged from 7% to 27% in 2021, before collapsing back to 1% this year.

And here’s another gyrating number: “Deficit spending as a percent of nominal GDP ballooned from less than 5 percent to 19 percent over twelve months, only to quickly contract back to 3 percent within the next 18 months,” Paulsen wrote.

With each change, officials argued the moves were necessary and contended that without them things would have been worse.

While that may be true, Paulson warned that over time a worrisome pattern has emerged as “policies have swung wildly between unprecedented stimulus and unparalleled tightening.”

The danger, he wrote, is that “monetary-policy weapons of mass destruction introduced in recent years [may] have added to the difficulties.”

To get a broader picture, Paulsen created a visual using a chart of consumer sentiment based on regular surveys the University of Michigan takes that ask if consumers’ current views of U.S. economic policies are favorable or unfavorable.

The chart plots responses based on the difference between favorable and unfavorable opinions. For example, if 25% have a favorable view and 55% have an unfavorable view of economic policy, the result would show up on the chart as a minus 30. 

For such a chart, Paulsen noted, the average since 1978 is a negative 9.4 with readings this year in the range of minus 30 to minus 40. 

“What is most interesting,” he added “is since 1978, stock market returns, by and large, have not been remarkable unless the perception of economic policy was near its average level” of between plus 5 and minus 15.   

In other words, the stock market did not generally achieve strong returns when consumer sentiment was strongly in favor of government economic policy, nor when sentiment strongly opposed official policy. 

“Stock investors are not necessarily rewarded when economic policies are deemed favorable,” such as when the Fed lowers interest rates or when taxes are cut, Paulsen wrote. “Nor should they hope for agendas that are worrisome.”

“Investors seem to flourish when they don’t really have to think about Fed and Treasury undertakings; that is, times when strategies are unimaginative and non-newsworthy,” he said. 

“Essentially, periods of ‘Ho-Hum’ policy have represented the stock market’s sweet spot.” 

And while Wall Street and Main Street are not the same, one can presume that “a boring policy agenda is similarly advantageous for the [broader] economy,” he added.

Going forward, Paulsen recommended officials “refrain from excessive and impulsive responses, … and avoid having frequent congressional tax and spend fights.” 

If they do, he sees hopeful signs as we head into 2023.

“We no longer have incredibly outsized monetary and fiscal growth rates or an extraordinary low yield structure,” the economist wrote.

The danger going forward is overreaction, he added.

“If the economy has a soft landing or only a brief and modest recession, perhaps the sweet spot could be achieved in the coming year,” Paulsen concluded.

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