Could U.S. Economy Hit Long-Anticipated 'Goldilocks' Scenario?

Even though the markets are feeling pessimistic, the economy appears headed into a rare, but oft-predicted, scenario of strong growth and low inflation.
Even though the markets are feeling pessimistic, the economy appears headed into a rare, but oft-predicted, scenario of strong growth and low inflation.

Whenever Wall Street starts talking about a "Goldilocks" scenario for the economy, investors should be wary. The term refers to a scenario where economic conditions are neither too hot nor too cold, but just right -- a period of strong growth, but little inflation.

It's easy to see why pundits seem to trot out the ideal -- and unlikely -- term as often as possible: Such a scenario makes it easy to peddle stocks and make lofty economic predictions.

Investors could be forgiven for dismissing this prospect as a fairytale. But now, even as markets fixate on all the tragedies unfolding and investor sentiment hits new lows, the U.S. economy may be the closest it has ever come to justifying a "Goldilocks" outlook.

Manufacturing Boom

The manufacturing sector, after all, is embarking on the type of boom that has historically coincided with the start of major bull runs. Meanwhile, core inflation remains subdued.

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In the past, declarations of Goldilocks scenarios have often come too early -- or been downright catastrophic. For example, many pushed the outlook during the winter of 2009, in the wake of the financial crisis, but were proven wrong: The economy still had plenty of challenges to muddle through.

High-profile pundits even forecast the scenario prior the savage downturn, a position that -- in retrospect -- could hardly have been more disastrously false.

But the evidence, this time around, is compelling.

A long series of evidence, including data from Thursday's Philadelphia Fed Index, has been indicating a U.S. manufacturing renaissance. And a look under the hood paints an even stronger picture of growth.

At 43.4, the index registered the highest reading since January 1984, a point that coincided with the start of among the largest sustained economic expansions in U.S. history. Economists had predicted the index would drop to 30 after roaring growth the previous month.

Orders and Optimism Rise

The new-orders index, meanwhile, picked up to 40.3 to post the highest reading since November 1983, economists at Ned Davis Research wrote in a client note. Shipments and unfilled orders reached their highest values since the summer of 2004.

Firms' optimism about prospects for the next six months, meanwhile, rose to its highest level since February 1993, when the U.S. economy was about to turn the corner following a different recession.

That optimism translates into business spending. More firms plan to increase their capital expenditure in the next six months, bringing that component of the index to its highest level in over a decade.

Industrial production also has grown 5.6% from a year ago, according to Ned Davis Research. The business-equipment segment, in particular, has gained 14.5%, representing its fastest yearly pickup in 13 years.

Doom and Gloom

Doomsayers have long warned that the turnaround was unreal, and some continue to insist that another downturn is around the corner.

"The uptrend that began in early July has come to an end," David Rosenberg, chief economist of Gluskin Scheff, wrote in a note to clients Friday. "Evidence is mounting that the economy and corporate earnings are losing precious momentum."

But the conference board's closely watched Leading Economic Indicators paint an entirely different picture.

The index rose for its eighth straight month in February, and its annualized six-month rate of change accelerated to 8% from 6.5% to mark the highest level in 10 months, Ned Davis Research notes.

With plenty of slack in the economy and labor markets, meanwhile, inflation continues to be subdued.

So while it's understandable that investors are cautious -- they've heard plenty of Goldilocks predictions in the past, only to be burned badly -- the scenario is now probably as real as it has ever been.