U.S. Economy
Recent Developments:
The U.S. economy has been firing on all cylinders, helped along by a strong rebound in household spending, business investment, and surprising strength in net exports. Unemployment continues to fall, wages are rising, and home and stock values remain high. Household wealth has been growing which is keeping consumer confidence high. These factors have lifted Americans’ spirits, along with a tax cut that has put more money in many Americans’ pockets each month. Lower taxes, better job prospects, elevated levels of consumer optimism, and increasing household net worth have been helping many Americans spend more which is accelerating economic growth. This spending is important because 70% of US GDP is dependent on household spending.
This strong economic activity has been absorbing remaining spare capacity in the corporate sector. The unemployment rate is at an eighteen year low, and there are more job openings than there are job seekers. Wage growth has been healthy and should move higher as skilled labor becomes even scarcer. Consumer price inflation finished Q2 above 2.0%, a sign that the U.S economy is bumping up against capacity constraints. The Fed, pointing to overall economic momentum and firming inflation, raised its benchmark interest rate for the second time this year.
Outlook:
In the current quarter, the U.S. is leading the charge among developed economies experiencing a reacceleration after a slow Q1. Second quarter economic growth in the U.S. should be around a 4.0% annualized rate. If realized, this would be the fastest pace of growth since the third quarter of 2014. Encouragingly, economic growth appears broadly based, with sizable contributions expected from consumption, business fixed investment, and foreign trade.
The U.S. economy, however, is not expected to sustain a 4% plus pace of growth indefinitely. For the year as a whole, 3% real GDP growth is expected, which if realized would be the fastest pace of growth in the United States since 2005.
One development worth watching closely is the potential fallout from the Trump administration’s recent string of tariff announcements. In addition to instigating trade policy uncertainty and political tension around the world, there are real risks which could impact both US households and companies doing business here and abroad. Tariffs have the economic effect of increasing prices and inflation by reducing competition. Shortfalls in product inputs could constrain supplies of finished products increasing prices. Additional downside risks include lower export growth and increased global inflationary pressures.
Economic Activity
*Based on the Federal Reserve Bank of Philadelphia’s U.S. Coincident Index, our gauge of U.S. economic activity registers a May 2018 reading in the 61st percentile.
Recent Developments:
Following a first quarter during which domestic and international equity indexes were generally negative, the second quarter produced mixed results. U.S. equity indexes posted positive returns while international indexes were negative. Emerging markets suffered through a difficult quarter as a strengthening US dollar put pressure on their currencies attracting investment capital back to the US (though we believe the long term growth outlook for these markets is favorable and valuations remain favorable). Fixed income markets were broadly negative as interest rates rose.
Macro factors provided a tailwind in the U.S. as the economic expansion became the second longest in history. Following June’s FOMC policy meeting, Fed Chairman Jerome Powell noted, “the economy is doing very well…the overall outlook for growth looks favorable.”
Outlook:
The macro environment remains supportive of global equity markets. Economic growth, a strong US dollar, tax relief for households and corporations and profit repatriation are strong tailwinds which have the potential to help push US stock prices higher. Strong earnings growth and improving capital investment should also support the US stock market. As it stands now, wage growth appears manageable, slow moving, and shouldn’t drive interest rates or inflation to the point where the equity bull market rides off the rails.
Our US equity market outlook therefore remains generally positive for the remainder of 2018 and into 2019. As long as the fundamentals for outlook and stock prices remains positive, volatility (absent market surprises) should remain subdued. We are however sensitive to signs of late-cycle dynamics in the U.S., including higher inflation and rising interest rates which could eventually put pressure on stock prices. Foreign markets, while attractively priced, could suffer if the USD strengthens and political turmoil in Europe and weaker economic growth in Japan continue.
Equity Valuation
*Based on the S&P 500 trailing twelve month Price-to-Earnings ratio, our gauge of U.S. equity valuation registers a current reading in the 16th percentile.
US fixed income markets are another story. The Federal Reserve has been using signs of economic acceleration to raise short term interest rates to head off inflation. They have done so a number of times in recent quarters and are expected to raise rates yet two more times this year. Long term rates on the other hand remain a bit of a conundrum as they have not been able to rise much beyond 3.0% for long.
As inflation picks up and the Federal Reserve continues to reduce its bond buying program, longer term interest rates should eventually rise from present levels putting downward pressure on bond prices. At some point, higher bond yields will present more competition for stocks as well. For that reason, we generally prefer bond portfolios that have shorter duration than the market as a whole and we are comfortable taking some corporate credit risk because of the current strength of the economy,
If you have questions, please contact us at any time.
Laurie W. Gerber, Client Development
GW & Wade, LLC
T. 781-239-1188
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