April Investment Comments
“With our policy rate in the range of neutral, with muted inflation pressures and with some of the downside risks we’ve talked about, this is a good time to be patient,” according to Federal Reserve Chairman Jerome Powell. Comforting statements like this have helped restore investor confidence just as Powell’s confusing statements last year may have triggered the fourth quarter market stampede. It is not unusual for new Fed Chairpeople to get their messaging wrong at first.
At this point last year, investors were concerned about rising inflation and higher interest rates. Fast forward twelve months and it appears that we might be in that fabled Goldilocks economy – not too hot, not too cold.
U.S. economic growth in 2018 was the highest since before the Great Recession. The current year is likely to be lower due to sluggishness outside the U.S. and the lack of incremental stimulus from tax cuts and extra government spending last year. Some economists peg growth below 2% while many have it in the mid 2’s for 2019.
Indicators are mixed early this year, which isn’t surprising as it would fit a recurring pattern. For many years, economic growth has started the year slowly before picking up nicely over the remaining three quarters. We suspect that the seasonal-adjustment factors used to annualize growth from the Christmas season into the first quarter may have become inaccurate.
The stock market was surprised by a low number of new jobs created in February. The 20,000 job increase marked a sharp deceleration from 311,000 in January and 227,000 in December. Parsing the data further, the economic sectors showing surprising strength in January (manufacturing, construction, and leisure & hospitality) produced the greatest shortfalls in February. These figures are based on surveys of households and businesses, and as such are best viewed over several months. The average of 186,000 new jobs over the past three months is actually stronger than the 2018 average.
Indexes put out by the Institute for Supply Management (“ISM”) show good growth in manufacturing, but at a slower rate than before, and an acceleration in the services sector to a very strong level. These indicators are consistent with a solid economy.
Consumer confidence is hovering around the highs set late last summer, and well above the trend of recent years. Much of this is driven by the perception that jobs are plentiful, along with continued acceleration in wage growth to the highest rates in many years. Retail sales in the fourth quarter were unimpressive, but strong employment prospects should help in 2019.
Wage gains can remain strong because worker productivity has started to rebound, rising 1.9% in the fourth quarter. If sustained, this would suggest 1.9% wage growth would be non-inflationary as workers are producing that much more per hour worked.
Measures of inflation appear to be stuck in the 1.5%-2.0% range. The Fed would like to see it higher before raising interest rates, hence the earlier comment that we seem to be in a not-too-hot, not-too-cold economy.
The biggest challenge to the U.S. economy in 2019 is the anemic rate of growth across much of the world. Europe’s economy grew by just 1.8% in 2018 and its expectation is for 1.3% growth this year. Even stalwart Germany is looking for its own economy to rise just 1.1%-1.8% this year. Canada barely grew in the fourth quarter, with 1.8% growth for all of 2018. Japan had a decent rebound in the fourth quarter, but barely offset half the sharp decline in the third quarter. China remains robust at 6.6% growth last year, but the outlook is for “only” 6.0%-6.5% growth in 2019. Anecdotal evidence from companies doing business in China suggests the private economy may be doing much worse.
Global growth is affected by weak export markets, including the impact of U.S. tariffs on foreign producers. Stock markets around the world heaved a sigh of relief over signs that the U.S. and China may be coming together to ease their trade dispute. President Trump extended the previous March 1 deadline for an agreement, putting aside the threat of additional tariffs to allow negotiations to continue. In addition, uncertainty over Brexit and the rise of insurgent political parties in Europe have added to uncertainty across the pond.
It is comforting that the stock market has largely recovered from one of the worst non-recessionary quarters in the past 100 years, the fourth quarter of 2018. Thankfully, the worst economic fears of that quarter have not materialized.
We expect economic growth in 2019 to be slightly below last year’s level, but to compare favorably with the rest of the developed world. We can’t imagine interest rates staying this low indefinitely, but a low inflation rate and ultra-low interest rates around the world are helping to justify modest U.S. rates. Our stock market philosophy is to stay invested unless there are compelling reasons for caution. Moderate economic growth and low interest rates warrant continued investment, with the caveat that the economy and secular bull market have already had a long run by historical norms.
Scott D. Horsburgh, CFA