Our call, going a little against the grain, is that we may be closer to the middle of the economic cycle than the end and that the effects of the tax cut and fiscal stimulus will extend the cycle further than most think possible.
The ability to fully deduct capital expenditures for the next 5 years and the shift to a territorial tax system that frees up trillions of dollars in unrepatriated profits, provides major incentives for companies to invest in their own businesses. As a result, this could boost productivity, support profit margins, and keep unit labor costs low enough for the Fed to stay on its current (gradual) path for rate increases.
The risk to investors may be to the upside, meaning that the best is yet to come for the economy this cycle despite the fact that it is already 9 years old. The longest cycle in US history is 10 years however, we are still trending well below the average cumulative GDP growth rebound per cycle of 23% (currently just 16%).
Last week the major indices closed modestly lower for the week despite positive economic data and earnings reports. The initial estimate of first quarter GDP (+2.3%) outpaced expectations for a 2.0% increase. Other economic data included growth in new and existing home sales, and durable goods orders. Consumer spending, which declined largely due to severe winter weather on the East Coast, should rebound as conditions improve. Corporate earnings continue to exceed estimates and the earnings growth rate (a blend of actual and expected results) has increased more than 20%. Technology stocks Facebook, Amazon, Alphabet and Microsoft all reported significant revenue and earnings growth yet their stock prices remain below their recent highs. Caterpillar, after announcing record sales and earnings, commented, “This may be the high-water mark.” Management may have intended to keep investor expectations in check rather than suggest deteriorating conditions. Even so, several Transportation stocks, after reporting better-than-expected results, sold off. And, despite other commentary in support of continued economic expansion, the markets sold off as investors reassess their assumptions for the remainder of the year. Bond yields rose; the yield on the 10-year U.S. Treasury Note closed above 3% for the first time since 2013.
Political events dominated last week; French President Macron meetings with President Trump highlighted the possible U.S. withdrawal from the Iran agreement in May. Tariffs remain a major issue as Europe and China seek negotiations to avert a trade war. A U.S. delegation plans to visit China next week to discuss trade issues. Meanwhile, some expect that a revised NAFTA Agreement could be finalized in the next few weeks. Hostilities in the Middle East continue as Yemeni rebels launched a ballistic missile against Saudi Arabian targets; an escalation of the conflict would raise concerns about disruptions in the region’s oil production which could lead to sharply higher prices.
The market’s subdued response to both strong economic data and corporate earnings reports is surprising but not unusual. February’s market correction continues to weigh on investor sentiment; overtime, though, the positive economic growth drivers should enable the equity markets to regain momentum.
*Source: Strategas and Pacific Global Investment Management Company
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.
Last Week's Headlines
1. Total existing-home sales, which are completed transactions that include single-family homes, townhomes, condominiums and co-ops, rose 1.1 percent to a seasonally adjusted annual rate of 5.60 million in March from 5.54 million in February. Despite last month's increase, sales are still 1.2 percent below a year ago.
Lawrence Yun, NAR chief economist, says closings in March eked forward despite challenging market conditions in most of the country. "Robust gains last month in the Northeast and Midwest – a reversal from the weather-impacted declines seen in February – helped overall sales activity rise to its strongest pace since last November at 5.72 million," said Yun. "The unwelcoming news is that while the healthy economy is generating sustained interest in buying a home this spring, sales are lagging year ago levels because supply is woefully low and home prices keep climbing above what some would-be buyers can afford."
2. “Consumer confidence increased moderately in April after a decline in March,” said Lynn Franco, Director of Economic Indicators at The Conference Board. “Consumers’ assessment of current conditions improved somewhat, with consumers rating both business and labor market conditions quite favorably. Consumers’ short-term expectations also improved, with the percent of consumers expecting their incomes to decline over the coming months reaching its lowest level since December 2000 (6.0 percent). Overall, confidence levels remain strong and suggest that the economy will continue expanding at a solid pace in the months ahead.”
3. The price index for gross domestic purchases increased 2.8 percent in the first quarter, compared with an increase of 2.5 percent in the fourth quarter (table 4). The PCE price index increased 2.7 percent, the same increase as in the fourth quarter. Excluding food and energy prices, the PCE price index increased 2.5 percent, compared with an increase of 1.9 percent. - Bureau of Economic Analysis
4. Disposable personal income increased $222.1 billion, or 6.2 percent, in the first quarter, compared with an increase of $136.3 billion, or 3.8 percent, in the fourth quarter. Real disposable personal income increased 3.4 percent, compared with an increase of 1.1 percent. - Bureau of Economic Analysis
5. Personal saving was $462.1 billion in the first quarter, compared with $379.8 billion in the fourth quarter. The personal saving rate -- personal saving as a percentage of disposable personal income -- was 3.1 percent in the first quarter, compared with 2.6 percent in the fourth quarter. - Bureau of Economic Analysis
6. Consumer sentiment improved slightly in the 2nd half of the month, shrinking the small overall decline for April. The final April figure was nearly identical to its 2018 average (98.9)-which was higher than any other yearly average since 107.6 was recorded in 2000 (which was, in turn, the highest yearly average in more than a half century). Tax reform and trade policies continue to spark spontaneous, or unaided, comments. The spontaneous comments about the tax reform legislation had a positive balance of opinion, but the trade tariffs generated a negative balance of opinion. The difference in the Expectation Index was striking: positive views on tax reform had Index values 28 points higher than those who made no mention of the tax reform legislation, and negative views on tariffs had Index values that were 28 points lower than those who didn’t spontaneously mention trade. Aside from the offsetting impact of Trump’s tax and tariff policies, the best simple summary of the current state of consumer confidence is that the economy is "as good as it gets." While consumers do not anticipate an economic downturn anytime soon, the long expansion has made consumers (and economists) somewhat apprehensive about future trends. Overall, the data are consistent with a growth rate of 2.7% in real personal consumption in the year ahead. - Univ. Of Michigan Surveys of Consumers
7. “Home prices continue to rise across the country,” says David M. Blitzer, Managing Director and Chairman of the Index Committee at S&P Dow Jones Indices. “The S&P CoreLogic Case-Shiller National Index is up 6.3% in the 12 months through February 2018. Year-over-year prices measured by the National index have increased continuously for the past 70 months, since May 2012. Over that time, the price increases averaged 6% per year. This run, which is still ongoing, compares to the previous long run from January 1992 to February 2007, 182 months, when prices averaged 6.1% annually. With expectations for continued economic growth and further employment gains, the current run of rising prices is likely to continue.
“Increasing employment supports rising home prices both nationally and locally. Among the 20 cities covered by the S&P CoreLogic Case-Shiller Indices, Seattle enjoyed both the largest gain in employment and in home prices over the 12 months ended in February 2018. At the other end of the scale, Chicago was ranked 19th in both home price and employment gains; Cleveland ranked 18th in home prices and 20th in employment increases. In San Francisco and Los Angeles, home price gains ranked much higher than would be expected from their employment increases, indicating that California home prices continue to rise faster than might be expected. In contrast, Miami home prices experienced some of the smaller increases despite better than average employment gains.”
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