Is 'Goldilocks' Back?

by Eric Knutzen, CIO, Multi-Asset Class, Neuberger Berman

As the Fed turns more dovish, a familiar fairytale heroine returns—but will there be another happy ending?

When Tim Berners-Lee conceived of the World Wide Web 30 years ago, he probably wasn’t thinking about how vital it would be for the distribution of amusingly captioned images of cats. And yet here we are.

Today, entire online communities study and debate the “lifecycle” of memes—even the “meme economy.” The leading theory says that a successful meme tends to be born in the geekiest corners of the internet before spreading via mainstream social media into everyday conversation, until eventually everyone gets sick of it and moves on to the next one. At that point, the discarded meme waits for a geeky wit to reinvigorate it, with some ironic twist, for a new generation. The cycle begins again. Some students of the meme even map this cycle onto those charts familiar from economics textbooks, tracing the evolution of great asset bubbles.

Comeback

I got to thinking about memes because I’ve picked up on new references to “the Goldilocks economy” in the finance press and analysts’ notes in recent weeks, after a break of more than a year. It’s been like seeing your millennial kids laughing at a cat joke that you assumed had burned itself out a decade ago.

Google Trends backs me up. It shows a spike in the search term “Goldilocks economy” during the complacent months of late 2006. There was another in the fourth quarter of 2017—we were among the geeks who got the meme going that summer, outlining our expectations for a “lukewarm porridge of low growth, low inflation and low interest rates.” And data from the first months of 2019 show evidence of a comeback.

Repeating Mini-Cycles

It’s understandable that our favorite fairytale heroine is back on the scene.

Since the beginning of the year, equity markets have rallied on renewed confidence that 2019 earnings won’t be too cold. At the same time, bond markets have held their own, reassured that the major central banks won’t be too hot in their pursuit of policy normalization. Last Wednesday, the Federal Reserve pressed home its recent dovish turn by confirming that another rate hike is unlikely this year and that its balance sheet run-off would be done by September, rather than December. In addition, equity implied volatility indices dropped to their lowest levels in months last week, and the index of Treasury market implied volatility hit its lowest level ever.

When a cycle is as long as the current one, it is tempting to think of it as an endless series of repeating mini-cycles. We would caution against this.

Last time Goldilocks was in the bears’ house, the fed funds rate was on its way from 0% to 1%; today, it’s at 2.5%. Wage growth was stagnating and had ample room to grow; today, it is ticking up steadily. The dollar had been declining for half a year; today, it’s at the top of a 12-month rally. Protectionism was theoretical cocktail-party talk; today, it’s a matter of high-level negotiation. Corporate leverage has gotten higher, loan markets have gotten bigger and covenants have gotten lighter.

Late-Cycle, Not Mid-Cycle

In other words, whereas 2016 – 17 was a mid-cycle recovery with a lot of expansionary headroom, in our view, we are now looking firmly late-cycle, with all the attendant challenges.

As we will describe in our forthcoming Asset Allocation Quarterly Outlook, we believe late-cycle growth depends upon a highly indebted China gaining traction with its stimulus measures, and a recovery in sentiment and data in Europe and Japan, where the central banks are running out of tools.

We believe those outcomes will be achieved, and if looser financial conditions and a weaker dollar follow from the Fed’s message last week, that will help. Nonetheless, those are very big contingencies. Uncertainty around them is apt to bring back market volatility at any time, with little warning. That means the confident asset allocation of 2017 would not, in our view, be appropriate for 2019.

And that explains why we are not spreading an old meme. We think our current “soft landing” theme better captures today’s reality: It reflects a benign outcome, for sure, but it recognizes that growth is on the way down, not on the way up. Goldilocks may be trending, but this is certainly no time to doze off on the assumption that things are “just right,” forgetting that there are bears out in the woods.

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