ECONOMIC OUTLOOK REPORT – 1Q-2020
Dreher Investment Services, Inc.
January 16, 2020
A Quick Review of 4Q-2019 Markets
The stock market provided a strong quarter (S&P 500 Index +8.53%), closing out the year on a positive note. With stellar returns in both the 1st and 4th quarters, the S&P 500 Index posted an astounding +28.88% for 2019, helping to offset the substantial losses the market encountered at the end of 2018. The Fed cut rates one time in 4th quarter, bringing the tally to three cuts in 2019. These rate cuts have proved to be what the market needed, reversing the inverted yield curve seen at the beginning of the year. The normalization of the curve moved the 10-Year U.S. T-Note to 1.92% after starting the quarter at 1.65%.
In spite of robust returns for 2019, a normalized yield curve and most analysts expecting positive returns for 2020, business optimism in both manufacturing and non-manufacturing sectors are experiencing some of the lowest levels we have seen during this expansion. If the markets can maintain their strength, they will have to do so while being tested on a multitude of fronts including the upcoming presidential election, geopolitical conflicts and anxieties associated with an aging economy.
1Q-2020 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 3Q-19 expanded at a +2.1% rate, revised above initial estimates of +1.9%. Overall growth for the quarter was once again driven mainly by consumer spending, with business investment continuing its declining trend, falling an additional -3.0%. The current estimate by the Atlanta Fed for 4Q-19 forecasts growth of +1.8%. Elevated levels of consumption will likely be a requirement for GDP levels to remain around 2% in 2020.
- Employment and Wage Growth – Initial jobs numbers for December came in below market expectations, at +145,000 and missed the consensus expectation of +160,000. Compounding December’s miss, both October and November reports were revised down to +152,000 and +256,000. The unemployment rate remained unchanged at 3.5%. Average Hourly earnings fell for the seventh time in ten months. Being ten-years into this expansion with record low unemployment, meager wage growth remains a mystery.
- Corporate Earnings – In 3Q-19, profits decreased -1.0% year-over-year while revenues grew +3.5%, showing signs that profit margins are continuing to tighten. Forecasters expect a -1.9% decline in profits with a modest +3.3% increase in revenues for S&P 500 companies in 4Q-19. If this comes to fruition, it would mark the first time since late 2016 that the S&P 500 has seen four consecutive quarters of year-over-year earnings declines.
- Inflation – December CPI posted at +0.2%, missing market expectations of +0.3% and bringing year-over-year to +2.3%. Core CPI rose only +0.1%, missing expectations of +0.2%, but increased to +2.3% for the year. Another miss on inflation versus expectations reaffirms that inflation is by no means out of hand. With trade deals showing signs of relief on the tariff horizon, stagflation or deflation should still be more concerning than inflation fears.
Other relevant topics that bear scrutiny:
Trade War – The signing of a phase-one trade deal between the U.S. and China is not the end of trade tensions, it’s merely a pause. The phase-one agreement put a halt to new U.S. tariffs and is going to halve the rate of some existing ones. In exchange, China promises to boost agricultural purchases from the U.S. The deal does little to address major structural issues, such as China’s subsides to state-owned enterprises strategic businesses and intellectual property theft.
It is unclear whether this temporary pause in the trade deal will eliminate uncertainty and encourage new business investment in fixed assets such as plants and equipment. President Trump has an embedded belief that trade deficits are a sign that the U.S. has been taken advantage of all these years. Unresolved trade policy remains a viable threat to the economy moving forward.
The Fed – The three short-term rate cuts by the Fed successfully un-inverted the yield curve in 2019. Some analysts are expecting another cut sometime in 2020 even though the Fed has communicated that it will likely remain unchanged throughout the year. Central banks thus far have provided the stimulus required to keep investors happy. Ambitions to return assets to the public markets seem to have been abandoned and central banks have accepted permanently larger balance sheets. The Fed will likely remain under pressure as the aging expansion continues.
SUMMARY OUTLOOK
The global economy continues to grow at its slowest pace in over a decade. Germany’s wobbly economy barely avoided a recession in late 2019. Due mainly to trade uncertainty, the U.S. economy remains hampered by an absence of business investment growth and falling productivity. The bright spot is that the U.S. consumers have shown resilience and the labor market has continued to strengthen.
STRATEGIC MARKET OUTLOOK
The U.S. equity market had one of its strongest years in recent history. Early progress on trade, low-interest rates and an accommodative monetary policy provided the fuel needed to move higher. Markets will likely be tested throughout the year from a myriad of geopolitical issues and the buildup to the Presidential election. Given recent reversal in economic data, we will view any downside market volatility in the coming quarter(s) as equity buying opportunities.
U.S. fixed income levels have seemed to stabilize as the equity markets continue their ascent. Central banks are likely to remain a key pillar of market support given their demonstrated willingness to push deeper into uncharted policy territory in an effort to keep the expansion going. In light of these facts, we will likely continue to increase duration levels with liquidity reinvestment transactions in the coming months.