What U.S. Blues?
The U.S. economy continues to show exceptional strength and resilience in the face of myriad negative headlines, as well as slowdowns in several parts of Europe and Asia. As the chart below shows, U.S. GDP growth bottomed in Q2 2016 and has risen sequentially in every quarter since. This trend is expected to continue for Q2 and Q3 of this year. Confidence also remains strong, with consumer confidence near its highest levels since 2000 and small business confidence at multi-decade highs.
When economists studied the Great Depression after the 1930s, one of the things that was cited as worsening the economic decline and prolonging the recession was the Smoot-Hawley tariffs. This protectionist trade policy was signed into law in 1930 and raised the tariffs on over 20,000 imported goods to the U.S. Despite nearly 90 years passing since then, whenever the term “trade war” surfaces in the media, folks immediately cite the mistakes from the 1930s and warn against repeating them.
The last year (2017) in the stock market will go down as one of the least volatile years on record. The largest pullback in stocks during the year was a scant -3%. Experienced investors know that historically the stock market has experienced yearly pullbacks in the neighborhood of double-digits. That made last year’s action in the market feel eerily calm to many portfolio managers, and begs the question, will 2018 be the year that investors see a pickup in volatility?
The answer is almost certainly yes, given that 2017 was such an anomaly in terms of low volatility. But it remains to be seen whether we will see just a mild pickup in volatility or something larger. The other element that is more difficult to predict is what will be the catalyst for any pullback. A sharp rise in bond yields? A geopolitical event? A policy shift in China? One never knows until it is upon us, but investors should not expect a repeat of last year’s ultra-low levels of market volatility.
One of the questions we hear in almost every client meeting of late is, “How can the market be going up when things are so bad out there?” Rather than try to identify and debate each item that could be referred to as ‘bad’, we think it would be more instructive to revisit market dynamics and the true drivers of stock prices that investment managers refer to when they talk about the strong underlying fundamentals behind this market.
The stock market continued its stair-step higher in Q2 amid slow but steady economic growth, decreasing inflation pressures, and low volatility on both the interest rate-front as well as equities. GDP growth started off this year on a lackluster note, but growth picked up in Q2 and is estimated to be stronger again in Q3. And this has come without rising bond yields and without escalating inflationary pressures, leaving investors to wonder if we are back in a “Goldilocks economy” like the one that characterized much of the mid- to late-1990s?
The current bull market (which began in 2009) will soon be entering its 9th year of expansion. That is quite a long time for a bull market to run without interruption, actually one of the longest on record. This has some investors worrying that we are getting into the late innings of this business cycle, and the time to cash in some chips and focus on playing defense is at hand.
Normally at this juncture in the cycle, one would be looking for areas of excess in the economy and financial markets and pointing them out as worrisome. This would include things like the economy overheating, inflation rates picking up, and interest rates rising in conjunction. But one of the conundrums this time around is that inflation has remained low, interest rates are near record lows, and economic growth remains subpar.