The news certainly isn’t getting better. Day by day, the data releases in the U.S. seem to disappoint. The China slowdown story is getting renewed traction. Finally, the most recent sugar rush for Europe is wearing off already. But wait, why is the S&P 500 up 7% and the NASDAQ up 13% so far this year? While we were sitting in our bomb shelters, the sun was shining and the birds were singing. This looks like we are climbing the wall of worry. So here’s another question. What leads what? Does the stock market forecast future economic outcomes or does economic data forecast future stock market returns? I’ll tell you this much. After nearly 30 years in this business I know that solely using economic data to forecast asset returns is a loser’s game. Maybe we should focus more on what the market is telling us about the economy. On second thoughts, since we are not in the business of forecasting the economy, maybe we should just ignore the wiggles in the data altogether.
I prefer to think of the economic data as ways of validating (or not) my investment themes. All the excitement generated over the Higgs Boson last week was not about its “discovery.” Its existence was assumed many years ago in the “standard model.” Rather, the ghostly trails left by decaying particles merely confirmed the math that had already been done. Still it took billions of euros and zillions of volts to do it. Likewise, we scrutinize the minutiae of economic data to discern whether our investment themes are likely to pay off. One bad data point may not change our view, rather, we see how the mosaic of data shapes up.
To take just one example, one of our themes is that China will not experience a hard landing – not this year, anyway. Two pillars support that theme. One is that the mix of Chinese growth is moving less toward investment and more toward consumption. Consequently, our global equity funds have a general tilt towards the Chinese consumer and away from industrial materials. We expect to hold this tilt for years. This week we will see Chinese GDP data. While we take all official data with a grain of salt, we will look to see if our thesis continues to be supported by the numbers. The other pillar is the idea that the Chinese have policy flexibility. They can re-expand and re-direct credit in the economy to keep growth from declining too fast. In the aftermath of the Lehman crisis, the Chinese were able to expand credit rapidly. We will watch the new loan numbers this week, as well, to see if credit is expanding or contracting.
We are perfectly willing to change our mind if the evidence no longer supports our view, but, critically, our portfolios are not led by data releases. We form our themes using all available information and then expect the numbers will validate what we already have decided.