Using 20th century data to guide 21st century investing

Deutsche Bank group chief economist David Folkerts-Landau reported that the S&P 500’s current correction-and-recovery episode, compared to the historical average, has the S&P tracking its average gains following prior 10%+ corrections. The markets are not only off of their lows, they’re almost all the way back to the levels they were at the beginning of the summer. Given last week’s nice stock performance, that trend seems to be holding for now.

It came to me this past week as I was collecting material for this note that the vast majority of our economic reports, and the conclusions being drawn from them about our overall economy, are perhaps out of focus. Most were initiated around the turn of the 20th century and, due mostly to habit and inertia, have remained the de facto guidelines for how we’re doing.

Not that the reports are wrong, per se, or that they’re “being spun” but that the emphasis continues to be more on the “what used to be” main drivers of our economy (the industrials) and not as much on the “what drives us now” components (the services). Those older data are almost all manufacturing/industrial-oriented and so only provide a partial insight into how and what we’re doing today.

As noted earlier this month by Dr. Mark Perry, using information from the UN through 2013, our industrial sector produced goods worth over $2 trillion – just about equal to the total output of the next six countries combined. So, while significant, to be sure, this today represents only about 15% of our total Gross Domestic Product (GDP). The major part of our economy is now in the services areas and is, therefore, where I think we should be concentrating our focus for the future inasmuch as investing is all about future growth. And not just in the US…

According to Ken Fisher, services accounts for 77.7% of US output, 68.4% of German output, 74.3% for Japan, and an even bigger 78.9% for France and 78.8% for the UK. China’s services sector comprises 48.2% of GDP-less than half, but still the biggest share of China’s economy.

How tell them apart?

According to the US Census Bureau, industry includes these sectors: manufacturing, mining, construction, electricity, water, and gas. On the other hand, services primarily consist of such businesses as truck transportation, messenger services and warehousing; information sector services; securities, commodities and other financial investment services; rental and leasing services; professional, scientific and technical services; administrative and support services; waste management and remediation; oilfield services; health care and social assistance; and arts, entertainment and recreation services…and lots more. Definitely not just minimum wage jobs as some would have you believe is the type work making up most service-related fields.

Additionally, services tend to require relatively less natural capital and more human capital than producing industrial products. This demand shift, in turn, requires more training and education of the workers in those sectors to properly support it. This too affects unemployment as in if you don’t have skills/training/education, you likely have one really hard time finding work in the US. Some examples of services-oriented jobs include computer programming, psychotherapy, tax preparation, commercial pilots, nursing and teaching…certainly not just hamburger flippers and store greeters, as some still think of as being what service-oriented jobs means.

You can hear and read many stories of how lower oil and other commodity prices have had a negative effect on the mining and materials sectors, as well as on those who export those items.

I think, however, you’ll find that, outside of the directly commodity-reliant sectors, most firms are in pretty great shape. The big multinationals might have trouble maintaining revenue growth overseas if the dollar stays strong, but the offset of reduced overseas costs due to that dollar should help reduce a lot of that impact. Financials and tech, home to some of our biggest, most flexible companies with great dividends, are in the catbird seat.

For instance, consider these three news items from the past week regarding some service-based firms. In a Re/code story, more than four in 10 customers say they go to Amazon first when searching for products online.Next,Nike said they’ll be doing $50 billion in annual sales by 2020 – just 5 years away. Finally, Dell bought EMC for $65 billion in cash and stock in the biggest tech takeover ever (so far). And it’s not just here in the US.

Information from Blackstone’s shopping malls in China supports the view that the consumer there is still spending at a reasonable rate. For example, last week, during China’s “Golden Week” national holiday, restaurant and retailers’ sales amounted to the equivalent to Kuwait’s total economic output in 2014.

ISM reports

The Institute for Supply Management (ISM) releases monthly reports on our manufacturing and service sectors. Matter of fact, their most recent releases show our factory sector is still growing very slowly. However, we’d have to go back to the first nine months of 2005 to find a stronger performance through the first nine months of the year than what we’ve had this year as orders remained solid and employment rose.

Production, manufacturing – those kinds of things are relatively easy to measure as they contain things that can be counted and tabulated. Services – not so much. For instance, selling an iPhone is a readily determinable cost but using the apps and internet access for who knows what – how do you accurately value that? Not easily or readily in today’s system, to be sure.

Summary

With about 20% of all the S&P500 companies reporting over this coming week, please keep these things in mind. As Ken Fisher observed, “Manufacturing has no magical predictive powers. Its surges don’t necessarily precipitate booming growth and its dips don’t always foretell broader declines.”

In addition, many (most?) service sector companies are consumer oriented with less exposure to the energy sector and less sensitivity to emerging markets and the strong dollar. Hopefully, these will likely have some good earnings and be set to continue in that manner.

And in their fourth quarter report issued last week, Goldman Sachs Asset Management had these general observations. “A range of cyclical economic indicators suggests the US economy remains on solid footing. The current economic recovery, despite running for more than six years, is holding steady. In fact, indicators ranging from housing to inflation to wages suggest the current expansion still has room to run. We believe a US recession remains years away.”

Cheers!

Mike

Securities and Investment Advisory Services offered through KMS Financial Services, Inc.

To get an overview of economic conditions, use this link. It’s updated monthly. http://www.russell.com/helping-advisors/EconomyMarkets/EconomicIndicatorsDashboard/EconomicIndicatorsDashboard.aspx

Past performance is not indicative of future returns.

Investing in securities of any type involves certain risks, including potential loss of principal. Investment return and principal value in a bond and/or securities portfolio will fluctuate so that investments, when sold or redeemed, may be worth more, or less, than the original investment.

Investing in sectors may involve a greater degree of risk than investments with broader diversification. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.