ECONOMIC OUTLOOK REPORT – 2Q-2018
Dreher Investment Services, Inc.
April 23, 2018
A Quick Review of 1Q-2018 Markets
U.S. equities struggled to find direction to begin 2018 and posted their first negative quarter in over a year (S&P 500 index -0.76%). A mix of politics, economics and corporate doings jostled and rallied markets intermittently in each of the first three months of the year. Volatility spilled over into the fixed income markets as well with the 10-Year U.S. T-Note trading between 2.40%-2.95% during the quarter.
Markets are in the process of digesting a number of changes implemented by the Administration in Washington. Time will tell whether their respective effect on the economic landscape stateside and internationally will be positive or negative. These changes include the tax reform package passed last December, a transition of leadership at the Federal Reserve, dramatic actions on import tariffs and numerous replacements of high-ranking cabinet members.
2Q-2018 Economic Outlook
From a fundamental standpoint, here are a few important measures of where the U.S. economy stands:
- U.S. GDP – The final GDP level for 4Q-17 was revised up to +2.9% from +2.5%. The economy is currently on track for a weaker first quarter. Consensus estimates for 1Q-18 now stand at +2.0%, down from initial estimates as high as +4.0%. A sharp drop in 1Q consumer spending is getting part of the blame for this downward revision. The supposed benefits from the tax reform passed late last year have yet to translate into measurable increases in either consumer spending or business investment. Even so, the 1Q-18 level is the highest first-quarter estimate in recent years. It is expected that GDP will resume its upward trend through the balance of this year.
- Employment and Wage Growth – For 1Q-18, payrolls increased at an average monthly pace of 201,000. The unemployment rate was unchanged for the sixth consecutive month, remaining at 4.1%. Wage growth remains modest even with the unemployment rate holding near this seventeen-year low. Looking forward through 2018, U.S. employment characteristics are expected to maintain these healthy levels. The unknown factor is whether and when wages will reflect meaningful growth resulting from the tax changes.
- Corporate earnings – In 4Q-17, both profits (+14.4%) and revenues (+7.8%) continued their increasing trend. The S&P-500 has now delivered six consecutive quarters of earnings per share growth. Estimates for 1Q-18 point toward even higher growth of 17%+ in profits and 8%+ in revenues. With the new pro-business tax plan in full effect, both profits and revenues could continue to exhibit strength through year-end.
- Inflation – CPI year-over-year rose +2.4%, and the core rose +2.1%. The U.S. inflation level is likely to continue rising gradually due to the Fed’s continuing “rate normalization” efforts, anticipated wage pressures and tariff-related rises in import costs.
Other relevant topics that bear scrutiny:
Trade war– Threats of tariff deployments that could prove disruptive to the U.S., China and other global economies rattled equity markets late in the first quarter. For now, investors remain hopeful that a practical resolution can emerge that will lead to a more level and competitive trade environment than what currently exists. The consequences of a fully-realized trade war would, as has been shown in the past, be detrimental to all participants.
Energy – A combination of a cheaper dollar, global economic recovery, geopolitical risk and production discipline practiced by producers stateside and abroad has boosted the price of crude oil +26.9% over the course of the past 12 months. This increase in price will likely be tested should tensions in the Middle East ease in the coming months. The underlying support for this acceleration in crude pricing is the consistent growth in global demand in the last few years.
Volatility returned to the markets in first quarter as transitions abound across the landscape generated in part by agenda items wielded by an unconventional Presidency, the uncertainty surrounding the policies of a new Chairman at the Fed and the business community’s broadly positive response to tax reform. All in all, the economy continues to show signs that growth persists at a moderate pace and is likely sustainable for the visible future.
STRATEGIC MARKET OUTLOOK
U.S. equity markets will likely continue to experience volatility throughout the coming year due largely to 1.) political matters and 2.) to the traditional swings in investor sentiment typically seen in the maturing stages of an economic recovery. As long as U.S. economic fundamentals maintain their current strength, however, we will continue to view any downside market volatility in the coming quarter(s) as equity buying opportunities.
U.S. fixed income markets absorbed record first-quarter short term treasury issuance, and 10-year yields rose roughly 40 basis points over the course of the quarter. For now, the Federal reserve remains committed to a policy of interest rate normalization at a pace that appears to be sensitive and suitable to economic growth. The Treasury yield curve has flattened noticeably in the last nine months, but we still see little near-term threat of curve inversion. As a result, and as has been our practice for some time now, liquidity reinvestment in fixed income securities will continue to reflect rate-sensitive characteristics for the foreseeable future with a more clear bias toward even shorter-duration.