ECONOMIC OUTLOOK REPORT – 4Q-2019
Dreher Investment Services, Inc.
October 17, 2019
A Quick Review of 3Q-2019 Markets
The stock market was positive once again on the quarter (S&P 500 index +1.70%). The S&P index is now positive +2.17% for the trailing 12 months after facing a major correction in 4Q-18. The Small Cap Index on the other hand, has yet to recover, posting a -10.21% for the same time period. Fixed income yields continued their descent as the 10-Year U.S. T-Note started the quarter at 2.00% and ended at 1.65%. The Treasury yield curve has technically been inverted for over a year, although the inversion at this time is not dramatic.
Markets have continued to digest a host of lingering issues from: trade tensions, heated geopolitical conflict and confusion over whether the Fed will continue to ease or hold off on rate cuts. Markets will likely remain under pressure from a myriad of uncertainties continuing to mount through year-end.
4Q-2019 Economic Outlook
From a fundamental standpoint, the U.S. economy has continued to slow down, as illustrated below:
- U.S. GDP – The final GDP level for 2Q-19 expanded at a +2.0% rate, revised below initial estimates of +2.1%. Overall growth for the quarter was driven mainly by consumer spending, posting its largest gain since 2014. Looking ahead, the Atlanta Fed had forecasted growth of +2.3% for 3Q-19, but signs of deterioration in manufacturing have reduced recent estimates to +1.7%. The negative effects of a prolonged trade war and an aging economic cycle are clearly starting to show.
- Employment and Wage Growth – Non-farm payrolls rose 136,000 in September following an August number that was revised up to 166,000. Employment growth has averaged just 161,000 for the year, down 28% from last year’s average of 233,000. The unemployment rate fell to 3.5% for the quarter. Overall, employment is slowing and wage growth remains stagnant.
- Corporate Earnings – In 2Q-19, profits remained unchanged (+1.6%) while revenues (+3.6%) continued to decrease from the previous quarter (+4.4%). The outlook for earnings has dimmed in recent months with analysts lowering earnings expectations for all 11 sectors of the S&P 500. Analysts expect a -4.7% decline in profits for 3Q-19. This will mark the fourth consecutive quarter of lower earnings. A U.S. – China trade deal may be the key to helping earnings reverse course.
- Inflation – CPI year-over-year remained unchanged at +1.7%, and the core rose +0.1% to +2.4%. There was less inflation than expected in September as signs of a slowing global economy have started to weigh on demand. Tariffs may boost inflation measures in the fourth quarter, but inflation is not likely to remain as big a concern going forward as either stagflation or deflation.
Other relevant topics that bear scrutiny:
Trade War – President Trump announced a partial trade deal which includes Chinese purchases of U.S agricultural products and the U.S. calling off tariff hikes that were set to take effect this month. Meanwhile, the threat of higher tariffs still hangs over the global economy. A round of 15% tariffs on roughly $160 billion of Chinese consumer goods is still set to be imposed on December 15th. This only compounds the uncertainty that global business leaders face as they attempt to measure consumer demand and plan future investments.
Regardless of whether the two sides can reach a short-term, narrow truce, many analysts remain pessimistic over the medium-term. Key issues including intellectual-property theft, forced technology transfer and complaints about Chinese industrial subsidies remain unresolved. Until a deal is reached that ends existing tariffs, global business investment may continue to stall.
The Fed – Fed Chair Jerome Powell stands committed to extending the current economic expansion, but the central bank has limited means to do so. Ahead of the 2007-2008 financial recession, interest rates hovered around 5%, leaving ample room for the Fed to lower borrowing costs in an effort to stimulate the economy. At the start of this year, the benchmark interest rate was half of that. The Fed has cut rates at the last two meetings and many analysts expect policy makers to announce a further reduction at the end of October. Lowering interest rates now may not leave enough ammunition to fight a protracted recession in the future.
The global economy faces difficult headwinds despite the recent decline in long-term interest rates. Lack of positive breadth in recent economic data on top of subdued consumer and even weaker business confidence has shown that rate cuts may not be the exact elixir needed for what ails the economy.
STRATEGIC MARKET OUTLOOK
U.S. equity markets have remained resilient throughout the year as valuations climbed to all-time highs during the quarter. Continued faith in the Fed cutting rates has seemed to be all that the market needs to shrug off negative news for now. Time will tell if this trend continues. New equity buying will continue to warrant consideration of somewhat more defensive selection criteria coupled with reduction(s) in allocation levels.
U.S. fixed income levels have continued to compress as Central Banks from across the globe continue to cut rates. Global interest rates are down more than -0.70% year-to-date. The efforts of monetary policy makers to lower interest rates and ease financial conditions may not be enough to halt the global economic slowdown. In light of these facts, we will likely continue to increase duration levels with liquidity reinvestment transactions in the coming months.