Each December we invite clients and prospective clients to a breakfast meeting to hear my outlook for the economy and markets. This year’s breakfast was held yesterday in Bethesda, and so I thought I’d summarize the main points from my presentation below for those of you who were unable to attend.
- We see incremental improvement in the economy, underpinned by improvements in housing, the labor market, consumer debt levels, energy prices, stock prices, and the banking system.
- Improvements in housing can be seen in the following metrics: 1) rising home prices; 2) increases in new & existing home sales; 3) improved housing affordability; 4) a reduction in the homeownership rate to more normal and sustainable levels; 5) rising household formations; 6) an ongoing rebound in residential investment; and 7) improvements in the availability and cost of mortgages.
- Improvements in the labor market can be seen in the following metrics: 1) the unemployment (U-3) and underemployment rates (U-6); 2) a sharp increase in job openings; and 3) rising wages.
- The consumer balance sheet is improving: 1) absolute levels of consumer debt and consumer debt as a % of personal income are both down; 2) debt service ratios have improved dramatically; 3) auto and student loans are areas to watch, but they remain small as a percentage of total consumer debt
- The keys to sustained growth in consumer spending are: 1) broaden spending beyond the relatively wealthy; and 2) broaden spending beyond stuff bought predominately on credit.
- Plummeting energy prices and the prospect of complete energy independence for the US have broad positive implications for the economy.
- The savings rate is likely to keep climbing (or remain elevated) due to lingering shellshock from the financial crisis and inadequate retirement savings; this will have negative implications for the economy in the short term but positive implications for the long term.
- Huge gains in asset prices (stocks, bond, houses) have led to a wealth effect, but mainly for the relatively wealthy; the middle class consumer so far seems disinclined to spend his or her higher earnings and the windfall from lower gas prices.
- A major positive for the US relative to other developed economies (read: Europe) is that our banking system has been recapitalized with greater regulatory oversight and restrictions on risky investments.
- Our conclusion is that an imminent recession for the US economy seems unlikely.
- However, caution is still warranted based on: 1) federal government debt and the looming entitlements problem; 2) economic weakness outside the US; 3) economic inequality is growing more pronounced; and 4) corporate margins are set to contract from record-high levels.
- Fixing the entitlements overhang through reduced benefits for future generations would free up capacity to make investments in infrastructure and education that would improve our competitiveness and accelerate economic growth.
- The growth disparity between the US and other developed economies has caused a surge in the dollar, which is creating a sharp drag on US exports.
- Economic inequality (ie, rising gaps in income and wealth) will be a long-term drag on economic growth as it affects consumption and savings rates and could lead to further political and social unrest.
- The middle class is further squeezed by increases in non-discretionary expenses on health care, child care, education, housing, and retirement savings (due to asset price inflation).
- Presidential polling data is illustrative of rising income/wealth disparity and class warfare.
- We believe stock returns will be lower in the future based on high valuation levels, high margins, and more subdued end demand.
- We expect long-term equity returns to approximate 6%-7%, consisting of 4%-5% earnings growth and 2% dividend yield.
- There are political options to accelerate economic growth and therefore earnings growth and stock-market performance: 1) address entitlement spending; 2) enact corporate tax reform; 3) repatriate corporate cash trapped outside the US; 4) invest in infrastructure and education; 5) promote immigration; and 6) reduce trade barriers.
We hope to see you in December 2016!