Economic & Market Update
Economic & Market Update: Using the Guide to the Markets to explain the investment environment
1. U.S. growth is set to decelerate in 2H19
The economic expansion enters its 11th year in July, making it the longest expansion since 1900. This economic expansion has been like a healthy tortoise – slow but steady. However, growth is set to decelerate further, and resume its expansion average pace of roughly 2%.
RIGHT: Consumption is the foundation of GDP
Consumption comprises 70% of GDP, and appears resilient for the second quarter. However, business fixed investment has weakened, and stronger net exports and a build-up in inventories that bolstered 1Q growth is likely to fade throughout the year.
2. Employment gains will likely be at a slower pace
Although wages experienced a modest acceleration, that is also likely to plateau from here as companies continue to resist raising wages, workers have limited bargaining powers given the decline of trade unions, and wages are pushed down by a wave of retiring baby boomers.
3. Corporate profits should achieve low to mid-single digit growth
4. Inflation will likely remain subdued through 2019
Information technology continues to make consumer markets more competitive and this, along with likely only modest wage growth from here, suggests that CPI inflation will hover at just under 2% year-over-year over in 2019, with inflation as measured by the personal consumption deflator likely undershooting the Federal Reserve’s 2% target.
5. The global economy has slowed but not stalled
Amid global trade tensions that have intensified this spring and remain unresolved, along with political turmoil across Europe and a slowing China, the global economy is facing a slowdown. We have seen manufacturing activity, as measured by PMI data, dip into contractionary territory (below 50) in many regions, most notably China, Germany, the Euro Area, Taiwan and Korea. Services PMI, which has held up better than manufacturing, is also beginning to deteriorate. Still, the global economy is not likely to stall in 2019.
6. The Fed may cut rates this year
Although the labor market is strong and growth has been solid, concerns about slowing growth ahead and negative impacts from the ongoing trade tensions between the U.S. and China have global central banks considering easing measures. The Federal Reserve is likely to cut rates at least once, but possibly multiple times, in 2019 as economic conditions deteriorate. Although the labor market is strong, growth prospects are in question and inflation remains subdued. The Fed has abandoned “patience” and “will act as appropriate to sustain the expansion.” Consequently, we expect two rate cuts in 2019.
7. Careful fixed income positioning is necessary in a changing environment
8. U.S. equity valuations are near long-term averages
Market volatility in the fourth quarter of 2018 brought equity valuations closer to their long-run averages; however, equity markets have moved higher this year and have achieved new market highs. Although valuations do not appear to be overextended, they are not cheap either. Although the market may have room to run, it is important for investors not to be positioned too aggressively, as many uncertainties, such as the Fed’s next move, trade and growth, remain, and may cause volatility ahead.
9. International stocks offer long-term opportunities
For most of the last three decades, both U.S. and international markets moved sideways. However, come 2011, U.S. markets took off while international markets remained stuck. In 2017, international markets started to outperform, they saw a reversal in 2018, leaving many to wonder if international strength was short-lived. However, international equities remain attractive over the long run thanks to strong economic growth and likely a downward trajectory for the U.S. dollar. Moreover, valuation measures suggest that international stocks are cheap relative to both the U.S. and their long term histories.
10. Broad diversification and careful portfolio management are required in late cycle
Despite slowing economic growth ahead, equity markets and the economy still have room to run. However, an older expansion and bull market call for a more disciplined approach, with smaller over-weights and under-weights relative to a normal portfolio. It will be even more important for investors to maintain well-diversified portfolios and be willing to make adjustments as late-cycle risks gradually rise.