While economic growth has slowed, as the third-quarter GDP
estimate showed last week (from 2.0% to 1.9%), several risks have lessened
since the Fed first lowered interest rates in July, namely the de-escalation of
U.S./China trade tensions, uncertainty on the Brexit front, and weakness in
manufacturing that appears contained. In our view, the U.S. economy remains on
solid footing, supported by a strong labor market, still-rising corporate
earnings, and low interest rates.
Fresh Data Show
There's Still Steam in the Stock Market Engine
Stock prices climbed 1.5% last week, reaching a fresh record
high[1.] The climb was fueled by slowing
but still-positive economic and corporate data, which beat market expectations.
We expect the four growth trends highlighted in recent data to outweigh ongoing
risks from trade uncertainty and slower domestic and global growth, keeping the
bull market moving forward, albeit at a slower pace.
1. A healthy labor market supports consumer spending
The economy added 128,000 jobs in October, well above the
consensus estimate and stronger than the 100,000 jobs needed to support new
entrants into the workforce each month. U.S. job creation was able to sidestep
the impact from the GM worker strike and the loss of temporary U.S. Census
jobs. The unemployment rate rose slightly to 3.6% from 3.5% the previous month,
a half-century low, as more workers were lured into the labor market. Average
hourly earnings grew by 3% from a year ago, besting consumer-price inflation
over the same time period.
Good news was also found in strong upward revisions to the
August and September employment figures, which combined for 95,000 additional
jobs. All told, the October gains and two-month revision boosted the
three-month average of jobs created to 175,000 from 157,000 previously. This is
a deceleration from the monthly average of 223,000 jobs created in 2018, but
still supportive of our view that a healthy labor market, modest wage growth,
and solid consumer spending can continue to power the economic expansion
2. Driven by the consumer, GDP growth is slowing but still
positive
New GDP data released last week showed that the economy grew
by an estimated 1.9% in the period from July through September, slightly lower
than the 2% pace posted in the previous three months. Consensus estimates
before the release expected a more marked slowdown, reflecting concerns that
trade uncertainty and sluggish manufacturing was taking a toll on the economy.
Yet consumers continue to show resilience in the face of these concerns, as
consumer spending, which makes up the lion’s share of the economy, rose by
2.9%.
This was a deceleration from the 4.6% posted last quarter
but appears strong enough to keep the economy near the average of this 10-year
expansion, now the longest in U. S. history. Moreover, spending was
broad-based, with big ticket durable goods up 7.6%, signaling that consumer
confidence remains strong in the face of trade uncertainty. This confidence
also showed hope in residential investment, where for the first time in six
straight quarters, the housing sector was a positive instead of negative driver
of growth. Low interest rates, stronger home sales, and a pickup in new
construction are signs that housing could remain on the plus side of the
ledger.
The economic picture was not all rosy. In fact, consumers
looked like the only highlight, with business investments and exports
subtracting from third-quarter growth. In contrast to consumers, business
sentiment has been notably downbeat, reflecting weakness in manufacturing,
trade tensions, and the overhang of decelerating global growth. Also released
last week was the IHS Purchasing Managers’ Index, a measure of sentiment in the
manufacturing sector. It was softer than expected and continued to show signs
of contraction in goods production.
We see manufacturing as a key pocket of weakness in the
economy; however, we also see signs that the sector could be stabilizing. In
2015, the ISM showed five consecutive months below the 50-index level without
the economy slowing to a recession2 (a below-50 reading is associated with
contractions). So far in 2019, there have been three months of below-50 readings,
but this month the employment and new orders subindexes sequentially improved.
The IHS Markit survey, a broader measure of manufacturing that includes smaller
firms and more sectors, is above 50 and is signaling modest growth ahead, in
our view, not a recession2.
3. Monetary policy is "in a good place" for the
bull market to continue
As expected, the Federal Reserve delivered on a third
straight reduction in benchmark interest rates, reducing the federal funds
target to 1.5%-1.75% from 1.75% -2.0%. Beyond the cut, there were other notable
elements of the Fed's announcement. By stating that monetary policy was
"in a good place," the Federal Reserve chair signaled a pause in
future rate cuts to assess the state of the economy with current stimulus
measures already in place. The past three rate cuts were viewed by the Fed as
insurance against rising risks from trade uncertainty and slowing global growth
rather than a mechanism for stimulating the still solid economy. Rate cuts have
helped reshape the yield curve from inverted, a historically reliable recession
indicator, to mostly flat – a signal that is consistent with modest economic
growth continuing, in our view.
The Fed's message to markets contrasted with the markets’
view that the Fed would cut at least one more time in the next six months. The
Fed's view, however, seems consistent with economic data on the economy and
jobs released this week, with both showing signs of fortitude despite looming
risks. However, The Fed's effort to boost inflation closer to its 2% target
continues to be a work in progress. Core PCE, a measure of inflation preferred
by the Fed, slipped to 1.7% in September, from 1.8% the previous month. The
Fed's concern that too-low inflation could reduce economic activity has been a
leading justification for cutting interest rates. Monetary stimulus can take
several months to be reflected in economic fundamentals, justifying the Fed
staying pat on rates for now, unless there is a meaningful growth and inflation
slowdown, in our view.
4. Corporate earnings are underpinning growing but more
volatile share prices ahead
Not to be outdone by economic data, the corporate sector is
also showing earnings growth. Approximately 80% of firms that have reported
third-quarter earnings so far have beat analysts' estimates, with companies in
the energy sector being notable laggards2. Corporate results thus far have also
reinforced our view that earnings will continue to grow modestly. However,
share-price growth will need to advance in the face of headwinds from
geopolitical concerns, like trade and Brexit, and the broad-based global
slowdown, making it a bumpy climb in our view.
Last week the economy reassured markets that it was still on
solid footing, beating expectations even as risks tied to trade and slower
global growth persist. In our view, investors can keep their portfolios on
track when risks are elevated by staying invested in the late stages of the
bull market, adding high-quality investments during bouts of volatility that
help diversify portfolios, and maintaining an appropriate mix of equities and
fixed income as a ballast against occasional swings in the market.
SOURCES:
1. FactSet
2. Bloomberg
No comments:
Post a Comment