“Everybody has a plan until they get punched in the mouth”
A space elevator has long been a theoretical dream project for the scientific community. It is exactly what it sounds like, an elevator tethered to the earth on one end, and to a satellite orbiting the planet at the same speed as the earth’s rotation on the other with materials moving back and forth between the two points. Right now it averages about $20,000 to put one kilogram of material into space, it’s estimated that a space elevator could bring that cost down to as low as $200 per kilogram and unlike rocket launches that get scheduled months or sometimes years apart, once the space elevator is built it could operate pretty consistently. If we want to get enough materials into space for a Mars mission this may be the only way to accomplish it. But there’s a problem, what can you build a space elevator out of that’s strong enough to hold itself up, but light enough that it doesn’t collapse in on itself? Scientists thought they had a solution with the creation of Polycrystalline Graphine. Polycrystalline Graphine is essentially a single string of carbon atoms that are held together by some chemical magic I do not understand. Touted as a huge breakthrough about a decade ago, subsequent testing has shown that while very strong, Polycrystallne Graphine is not very durable, in that it is too prone to cracking after long term use. While a sheet of this stuff only a single atom thick can hold up a soccer ball making it the strongest material ever created, if it can’t hold the soccer ball for more than a couple months without cracking apart it’s probably not the kind of thing you want to use to build a space elevator. Strength is great, but without durability, without toughness; it’s fleeting.
I bring this up to talk about our economy. The economy is currently very, very strong. Unemployment has been less than 4% for over a year, construction is going gangbusters and economic growth while it’s bounced around from quarter to quarter has averaged above 3% for the past year up to the first quarter of 2019 and the estimates for the second quarter keep us in that range. So why am I constantly writing about recessions and market corrections when we seem to be doing as well economically as ever? It’s because I’m worried about durability. I’ve written a lot over the past seven or eight months about how the tariff threats, cool offs and then counter threats can almost be tracked by a stock market chart. Certainly a major trade war could have very deleterious effects on the economy and overwhelm the strength in other areas so the market volatility that has been in lock step with the U.S. / China trade news makes sense. What makes much less sense is the market reactions to the Fed and their policies. If our economy is really, durably strong then why can’t we absorb slightly higher, but by historic standards, very low rates? Why did it take the rumor of a Fed rate cut coming this year to snap the markets out of their May swoon? If a seawall is strong it can take a few big waves – why every time a wave is forecast does the market assume the wall won’t hold?
Now maybe the Fed does cut interest rates and there is no recession, but in a truly strong economy the Fed is supposed to raise interest rates so it actually has somewhere to go the next time the economy starts to slip – that’s what the Fed started doing in late 2015. For the next three years they only raised rates 9 times ( about once every three Fed meetings) and the total increase was only 2.25% - bringing the rate to 2.25-2.5% from the zero bound rate we had for almost seven full years. This is the slowest and smallest the Fed has ever raised rates, and yet the markets panicked in December of 2018 when the Fed made that last quarter of a point hike. How durable can this current economic recovery be if the housing and construction boom will end at 5% interest rates? Is the economy strong, or is the fact that you can still borrow money so cheaply and easily allowing companies to gloss over the cracks that are beginning to form? But if that is the case, the Fed keeping rates extremely low can allow this financial spackling to continue certainly for the rest of this year and probably far enough into the following year that the economic news and election news get blended together to where the actual economic numbers are forgotten for a couple of months.
Since we don’t publish this newsletter in August and since I’m away for the first two weeks of that month – I certainly hope nothing happens of any significance anytime soon. The next Fed meeting doesn’t conclude until July 31
st so we won’t know which way they are leaning until then. Even absent a rate cut if they change their language to a more dovish tone that might satisfy the markets anyway. But should the Fed really cut interest rates? The official inflation numbers the Fed uses (as meaningless as they may be to your life as I’ve written about before) show very low inflation, unemployment is as low as it’s been in a long time even adjusting for those who want full time work and are only working part time etc. and the stock markets are in general near all-time highs. So what would make them think they need to cut interest rates; because the stock market reacts badly to hawkish statements from the Fed and well to dovish statements? Since when is the level of the stock markets supposed to control what the Federal Reserve does?
Like Polycrystalline Graphine the economy is very strong, maybe as strong in pure unemployment and economic growth numbers as it’s been in decades – but also like that miracle metal it seems to lack durability. For today and tomorrow and maybe the next 12-18 months it can hold one million times its own weight, but longer term you can see the cracks. How the tariff issues play out and how accommodating the Federal Reserve decides to be will ultimately decide how much longer the longest recovery in U.S. history will continue. In the meantime we will position our investment portfolios for cautious optimism and hope this shift from growth outperforming value to value outperforming growth continues to take place as the next year or so goes by. But we are going to continue to monitor if the Fed decides to assert its independence or if the Chinese decide they can live without a trade deal and see if our economy is like a seasoned boxer who when punched in the face carries on and fights harder, or like a classic bully that runs away as soon as they are challenged.
Enjoy the rest of your summer. Keeling Financial as you know is about more than just investments; how to set up your lifetime income plan after retirement, how to protect your assets for your spouse or children, how to fund those charities you love but get the government to chip in 15-35% of your contribution by making sure you preserve your deduction – these are just some of the strategies we help people implement that can be worth far more than a few tenth of a percent of investment return. If you know anybody looking for help with any financial issues, make us your first call.