“Goldilocks….Slow Mo”

There used to be a phrase commonly used by economists and market analysts when discussing the economy which you don’t hear much anymore. The phrase was the “goldilocks economy”. It meant that the economy was growing at a reasonably good pace, enough to support rising corporate earnings, without generating high inflation and, therefore, was “not too hot and not too cold”, but “just right” to keep the stock market happy. That was back in times when “normal” economic growth was something like 3-4% real GDP, like we had in the 80s and 90s.

 Today, we have a “new normal”, which is slow (1-2%) growth, slow job creation, slow consumption, and low inflation…..and what one could describe as a “goldilocks economy” in slow motion, which appears to be just fine with investors, thank you, as the stock market moves to record highs. Why are investors happy? In this case, it is primarily because slow growth is causing the global central banks to maintain a highly accommodative monetary policy. In fact, today (April 29), it appears the European Central Bank may be prepared to lower interest rates. This on top of what we expect will be continued highly accommodative policy stance on the part of the U.S. Federal Reserve.

The market likes this “goldilocks economy” because the “easy money” policies appear to have no end in sight. The idea is excess liquidity pumped into the financial system by the central banks will find its way into the stock market, with the U.S. right now being the market of choice for most global investors. This has favored, and continues to favor, large-cap dividend –paying stocks which are highly sought-after in the current environment of very low interest rates. Bond yields have become so low, that fixed income investors have been seeking higher returns in higher yielding blue chip stocks. This “reallocation” of assets has changed the investment risk paradigm and actually increases financial system risk, as stocks are inherently more volatile than bonds.

The good news is the “new goldilocks” economy appears to be doing reasonably well, albeit still at a slow pace. Within this backdrop, we don’t see the new “risk paradigm” changing much in the near term, which is positive for stocks. From a financial planning perspective, one of the best ways to protect against higher systematic risk is through diversification: holding a portfolio that includes a number of asset classes that are not highly correlated. While this will result in growth that may be slightly below that of the stock market when stocks are rising, it protects the portfolio through reduced downside risk when stocks are declining and should result in higher risk-adjusted returns over the long term.