Economic Indicators March 2019
Prepared by Kim W. Suchy
Optimum Investment Advisors, LLC
The economic foundation of the U.S. economy remains strong despite the recent blips caused by interruptions stemming from the government shutdown. This past week, the Dow blew through 26,000 (again) after rising for nine straight weeks – the longest weekly winning streak since 1995. In fact, next week will mark this bull market’s 10th birthday which was born on March 6, 2009.
Over this lifecycle, the S&P500 twice avoided 20% corrections by the narrowest of margins (0.6% in 2011 and 0.2% last fall). Note, a 20% correction signifies that a bear market is present. These two sizeable drawdowns tested the wills of many yet patience always prevailed…in fact, at the time of this writing, The Dow is just X points X% from its all-time high.
After the best January since 1989 and the worst December since 1931, the Dow, Russell 2000 and NASDAQ have surged 20%, 25.5% and 21.6% respectively since December 26th. Market timers had better have gotten that one right. If not, the train has left the station and it’s very difficult to catch up. If there’s any consolation, the bull market is also tethered to what will soon be the longest economic expansion in American history. The previous record of 10 years (1991-2001) will be surpassed if the economy is still growing in July of this year. All signs suggest this will happen as there are no indications of recession. By definition, a recession is underway after two consecutive quarters of negative GDP. With the tailwinds of growth guiding the economy, it appears the current bull economy has plenty of runway.
The market has fought back with an unprecedented vengeance. Certainly, the favorable talks associated with China trade have served the market well but perhaps the bigger catalyst was the Powell Pivot. Fed Chair Powell stated that the Fed won’t raise interest rates again until inflation accelerates which was dovish pivot that left investors betting against any further hikes in this economic expansion. The implication here is that the Fed may be willing to tolerate core inflation above its 2% target for some period of time. Of course, the “some period of time” reference is contingent on inflationary variable undercurrents and the speed of which they may work their way through the economy. Some variables, i.e. energy prices, can spike and sustain themselves at high levels sending direct (transport) and indirect (supply) price shocks throughout the economy. Hitting the brakes sooner rather than later in this instance would be a prudent measure. Powell impresses me as a well-read sort of guy and I trust he read Goldilocks and knows when the economy is running too hot, too cold or is just right.
In addition to dropping the reference to “further gradual increases in rates” Powell implied the next rate move could just as likely be down as up. Finally, the Fed also announced a more flexible approach to shrinking their bond portfolio, another acknowledgment of last fall’s financial market angst over tighter monetary policy. We believe it is now the Fed intention to end balance sheet normalization later this year rather than in 2020.
Here is your look at developments in the global marketplace.
Positive Developments:
· The stock market is in overdrive mode, posting an impressive winning streak that has restored almost three-fourths of the Q4 losses. Interesting how retooled Fed policy and a more accommodative trade atmosphere turns market lemons into lemonade.
· There has been progress in US/China trade negotiations. Trump waived the March 1 deadline for a trade agreement with China and has begun preparing for a summit with Chinese President Xi.
· Consumer confidence improved in February, snapping a 3 mo. losing streak, after the U.S. government ended the longest shutdown in the country’s history and the trade issues wane. The confidence index climbed to 131.4 from 121.7, when economists that called for a rise to 124.9..this is surge is an 18-year high while consumer expectations posted the largest monthly gain since 2011. This is likely related to the recent easing in financial market conditions at the same time that political developments have also turned more constructive.
· The Producer Price Index (PPI) for final demand fell 0.2% in December, its first decline since February 2017. The main driver was a 5.4% drop in energy prices, the most since September 2015. Conversely, food prices jumped 2.6%, the most since February 2011. PPI ex-food and energy slipped 0.1%, its first decline in a year.
· Through this week, 89% of the companies in the S&P 500 have reported actual results for Q4 2018. With regard to earnings, 69% of companies reporting beat estimates. In aggregate, companies are reporting earnings that are 3.5% above the estimates. In terms of revenues, 61% of companies reported actual revenues above estimates. In aggregate, companies are reporting revenues that are 1.1% above estimates.
Neutral Developments:
· In December foreigners sold a record $91B in US stocks and bonds. Roughly 85% of this amount, or $77B, was the rest of the world selling US Treasuries. Despite this significant upward pressure on US rates during the stock market rout in December 10-year rates still went from 3.20% in November to 2.68% in late February. This reveals how strong the domestic bid is from pension funds and banks for US Treasuries at the moment.
· Real GDP increased at a 2.6% annual rate in Q4, above the consensus of 2.2%. But it slowed from 3.4% in the previous quarter, partly due to the government shutdown and the wildfires in California.
· Durable goods orders rose 1.2% in December led by civilian aircraft and vehicles. Ex-transportation, orders edged up 0.1%. Nondefense capital goods orders ex-aircraft, or core business orders, fell 0.7%, down in 4 of the past 5 mos., indicating weak capex demand. On a y/y trend basis, durable goods orders moderated to 5.3%, while core orders edged up slightly to 4.1%, but both were close to their slowest rates since the spring of 2017.
· Retail sales declined 1.2% in December – the biggest monthly drop since September 2009. Internet retail sales declined by 3.9% and department store sales slid 3.3%, while health and personal care store sales fell by 2%. The early Thanksgiving generated an early holiday shopping season, slowing the total for December sales, but the biggest reason for the drop was that sales at gas stations plunged by 5.4% due to falling gas prices. Overall, retail sales rose 2.3% for the full year of 2018. Since falling gasoline prices put more money in consumers’ pockets.
· Home prices in 20 U.S. cities rose in December at the slowest pace in 4 years, as buyers balked at purchases amid still-elevated housing costs and the Q4 falling stock market. The Case-Shiller index of property values increased 4.2% from a year earlier, after a downwardly revised 4.6% in the prior month. Nationally, home prices climbed 4.7 percent, the least since 2015. This may reverse itself as equity markets have improved and rates remain in a relatively tight range.
· FactSet reports that for Q1 2019, 68 S&P500 companies have issued negative EPS guidance and 25 issued upward revisions. With respect to valuation, the forward 12-mo. P/E ratio is 16.2 which is below the 5 yr. avg. of 16.4 but above the 10 yr. avg. of 14.7
· Pending home sales rebounded strongly in January, up 4.6%, its first increase in seven months and the most since October 2010. On a y/y basis, contract signing was still negative at -2.3%, but the pace of decline moderated significantly. Activity was spurred by lower mortgage rates and the end of the government shutdown.
Negative Developments:
· Britain’s March 29th exit from the European Union (EU) is looking to be a potential disaster for both the British Pound and the Euro. Ironically, Brexit uncertainty is good for the U.S., since the U.S. dollar is the beneficiary of international capital flows (keeping the Dollar strong and keeping Treasury yields suppressed).
Already, Britain appears to be sliding into recession i.e., Land Rover Jaguar announced 4,500 layoffs and is short of capital. Honda announced that it will close its plant in Swindon, England, employing 3,500 workers, in 2021. Some EU automotive companies, like Porsche, have warned its British customers that a 10% surcharge may be added after March 29th since there is no agreement between Britain and the EU on vehicle tariffs. Economies hate uncertainty, since businesses and consumers tend to postpone purchases, which causes the “velocity of money” to grind to a halt and prices to fall (deflation).
· According to Fortune, despite broad market moves higher, an expanding economy and unemployment at historical lows, a record 7M Americans are 90 or more days behind on their auto loan payments.
Within the various consumer debt categories, student loan debt holds the #2 spot (behind mortgage debt), ahead of credit cards and auto loans. As of mid-2018, over 44M borrowers owed more than $1.5 trillion in student loan debt (source: Forbes). The FDIC has stated that nearly 20% of those loans are already delinquent or in default. That number could balloon to 40% by 2023, according to a report by the Brookings Institution. The “buy now, pay later” mentality is creeping higher as a potential drain on household budgets.
· Existing-home sales ran at a 4.9M a/r in January as sales were even lower by 1.2% than the 3-year low they hit in December. They were 8.5% lower than a year ago. The median price of a home sold in February was $247,500, up 2.8% compared to a year ago. That was the slowest annual price growth since 2012.
· U.S. new-home construction in December fell to the lowest since September 2016, as builders held back during a turbulent month for financial markets. Residential starts fell 11.2% to a 1.1M a/r after a downwardly revised 1.2M pace in the prior month.
Over this last market rebound (12/26/20128 to present), the four strongest sectors have been industrials, information tech, consumer discretionary, and energy. There is a lot of growth imbedded in these sectors. The “safe” sectors, utilities, communications, consumer staples, and real estate, have lagged their growthy peers nonetheless they have posted very respectable returns.
With regard to international stocks, they continue to produce respectable gains. A close eye is kept on the U.K. as Brexit developments could change the landscape tremendously. China has surged ytd on hopes of a palatable trade agreement albeit depressed levels prior to negotiations.
With respect to bonds, the 10-year Treasury closed the month yielding 2.72%. The 2-year Treasury closed yielding 2.53% and the 10/2 spread was 19 bps just one point wider than last month.
As noted above, the U.S. economy slowed, as expected, in Q4 of 2018 as the Commerce Department reported GDP came in at a 2.6% rate. The growth rates in the two previous quarters were 3.4% and 4.2%. Specifically, the slowdown was caused by a reduction in inventory building, a decline in growth for U.S. government spending and a drop in state and local government spending. Consumer spending, which accounts for 2/3 of the economy, rose at a 2.8% rate. Exports and cap-ex both improved. For the full year 2018, the economy grew at a 2.9% rate, up from 2.2% in 2017.
Looking ahead to the balance of 2019, we can expect to see a slow start to the year caused by the U.S. government shutdown and the fires in California before a pick-up later in the year. Assuming the Fed stays “patient” and on the sidelines for most of the year, we may very well see the economy and U.S. equity market celebrate their 10th birthdays in 2019.
As always, if I can be of additional guidance, please feel free to call me at 312.456.3319.
Best regards,
Kim W. Suchy
Investment Counsel