Peering through the trees of short-term noise to better see the forest of long-term economic trends and market conditions is the constant charge of every investor. The unending, cacophonous news cycle clutter has increased in recent years and shows no indication it will ebb. The current strains are as confusing as we’ve heard in a while.
December saw a big stock market decline, a government shutdown, trade talks with China, worries from Brexit, and the 9th increase in short-term rates from the Federal Reserve. Rapid developments on several fronts sent many in search of Dramamine. It was no time to be sanguine.
Fortunately, the new year has seen share prices rebound and interest rates continue to fall as the Federal Reserve made softer sounds of stopping its current tightening spree. After dropping 20% from October 3rd to December 24th (Merry Christmas!), the S&P 500 has surged 11% year to date. The index is now back to within 5% of its all-time highs. Sighs of relief abound.
The news is not all good. Retail Sales numbers for December were alarmingly bad, the housing market continues to slow, earnings estimates have come down significantly, and reports of a global economic slowdown are building. There is some concern that the US consumer is losing his resilience.
Our take is that the confluence of an additional Fed rate hike, the government shutdown, and trade uncertainty were among the holiday season buzz-kills for investors. While the consumer’s buzz may have been dampened to just a hum, his/her financial resilience remains firm. This is important because consumers must be both willing and able to spend. If one component fails, the overall number drops. For obvious reasons, the consumer’s ability to spend is ultimately more important than willingness because willingness can be remedied more quickly. Indeed, the consumers willingness to spend is recovering.
The backward look to a depressed holiday season may continue to show softness from that period. But at this point the weak retail sales figures for December are more likely to prove an anomaly. The recovery in stock prices along with the Federal Reserve’s voluntarily benching itself has improved the outlook for the economy, stocks and consumer appetites. This market swoon and recovery have happened quickly and inflicted momentary pain. With a sense that all of that is behind us, what lies ahead?
Throughout the fall we wrote that markets were repricing to lower growth expectations. The US Gross Domestic Product is expected to grow around 2% for this year and next. This is a good deal slower than the 4.2% growth rate from the second quarter of 2018. GDP growth of 2.0%-2.5% has been the trend rate over the past ten years. Despite the short-term boost from tax cuts and additional fiscal spending, the US is returning to that moderate trend, and THAT’S OK! As we enter the 10th year of the current economic recovery, Ok IS Ok. The economy is continuing to grow, inflation is low, interest rates are low, unemployment is low, wages are growing and goldilocks is in her heaven.
The silent killer is the growing debt. The United States is spending about $80 billion more a month than it collects in receipts, and that number will increase to over $100 Billion a month in the next few years. The growing deficits require additional borrowing and ever-increasing debt, the service of which can act as a damper on economic growth. So the new choruses of “deficits and debt don’t matter,” are lost on us. The growing debt is a serious concern and will have to be confronted eventually. In the near term, however, the sun shines and hay is being made. Guard yourself against the warm, calm halcyon breezes and keep a close eye on risk. Though volatility appears to have gone into hibernation again, the coming months are more likely to bring a return to volatility. Stay focused on good companies with strong cash flow and rock-solid balance sheets. Ok is ok, but make sure you have a seat when the music suddenly stops.