What If It's All Fake Growth?
One of the mysteries of the current economic cycle is that we've had lots of recession indicators without the actual recession. One of my favorite economists to follow on Twitter, Philip Pilkington, may have figured out the mystery: our economic growth is fake. On Thursday, he laid out his reasoning in this thread:
2/ I barely need to highlight how many leading indicators are screaming ‘recession’ in the US. Let’s just look at PMIs. Manufacturing PMI is at 47.6, worse than the beginning of the 2008 recession. pic.twitter.com/xyMmtw97BV— Philip Pilkington (@philippilk) September 7, 2023
4/ Yield curves signal financial conditions, not real economic ones. But the yield curve is at pre-Great Depression levels. pic.twitter.com/SNX41nruXJ— Philip Pilkington (@philippilk) September 7, 2023
6/ The other day a friend asked me is this normal. And I started to think just how abnormal it is. Then I started to think: maybe its all fake. pic.twitter.com/MnBY121VeC— Philip Pilkington (@philippilk) September 7, 2023
8/ Spending is being driven, in part at least, by the Biden admin’s IRA. The Treasury is bragging about how the act has unleashed a building boom. pic.twitter.com/cve2O7CCYL— Philip Pilkington (@philippilk) September 7, 2023
10/ This would explain why we’ve seen an unusual dip in productivity since the end of 2021. The growth is simply fake. A sort of economic Potemkin Village - quite literally in fact because the government are paying people to build things with no current market value. pic.twitter.com/1CnGyEZ6lK— Philip Pilkington (@philippilk) September 7, 2023
11/ The question then is: can it last? Did the Biden admin, consciously or otherwise, time the IRA just right to keep out of recession before the election? We’ll soon find out, I guess.— Philip Pilkington (@philippilk) September 7, 2023
Can They Keep This Up Until After The Election?
That's the question Pilkington addressed in his follow up thread on Friday. Cutting to the punchline of it:
10/ That looks perfectly possible. But here's the kicker: non-manufacturing construction growth may not be flat. Recent data shows it could have peaked and be about to contract, in which case even more manufacturing construction would be needed. pic.twitter.com/LU4z7ZpeeK— Philip Pilkington (@philippilk) September 8, 2023
Unsurprisingly, Pilkington concludes on a note of uncertainty (he is an economist after all).
11/ In conclusion:— Philip Pilkington (@philippilk) September 8, 2023
- The US economy is on a knife edge.
- It is being supported by construction spending.
- This is being supported by IRA subsidies.
- Whether these subsidies can continue to support the economy until the election is an open question.
Investing Amid This Uncertainty
If Pilkington is right, one would expect our economic chickens to come home roost at some point, and for that to be reflected in a bear market. The problem with betting on that outcome now though is that you would lose money waiting for that bear market to happen.
Another approach to this sort of uncertainty is to bet on a handful of top names continuing to do well, and hedging in case they don't (or the market as a whole tanks). We call that the Hedged Portfolio Method. Here's a real-world example from earlier this year.
This was the hedged portfolio our system presented to an investor on March 2nd who had $3 million to invest but was unwilling to risk a decline of more than 30% over the next six months.
Screen captures via the Portfolio Armor web app on 3/2/2023.
A few notes on the portfolio above:
- This was a $3 million portfolio, but our system will present this for dollar amounts as small as $30,000.
- The securities in this portfolio were on Portfolio Armor's top names ranking of the ones with the highest estimated returns over the next six months, net of hedging costs.
- One of these names, Nvidia (NVDA), was also on our "cash substitutes" list: these are securities that generate large net credits when tightly hedged. After rounding down equal dollar amounts of each of the seven different securities in this portfolio, our system used a tightly collared NVDA position to absorb most of that leftover cash.
- The expected return here was 11% over the next six months.
How That Hedged Portfolio Actually Did
Net of hedging and trading costs, this portfolio returned 18.67% over the next six months, versus 14.28% for the SPDR S&P 500 Trust ETF (SPY) over the same period.
Perhaps something to consider for those of you who are risk averse here. If you don't want to risk a 30% decline, you can use this approach with decline thresholds as low as 2%.
If You Want To Stay In Touch
You follow Portfolio Armor on Twitter here, or become a free subscriber to our Substack using the link below (we're using that for our occasional emails now). If you'd like to have your system create a custom hedged portfolio for you, you can join the Portfolio Armor web app. If you do, contact me via the site, and I'll throw in a free six-month premium subscription to our trading Substack.