By Gary C. Sanger, Ph.D., CFA
It has been six months since passage of the Tax Cuts and Jobs Act, and we are beginning to see its stimulative effects on the U.S. economy. The post-recession bull market is now over nine years old, and shows no signs of slowing in the near future. Despite this growth, inflation remains low. The core inflation rate (measured by the personal consumption expenditures index) was 2% over the past 12 months, just equaling the Fed’s long-run target. Following a slow Q1, the U.S. economy is expected to grow at a 3.8% rate in Q2 and 2.9% overall for fiscal 2018 (vs. 2.3% in 2017). The Conference Board reported that U.S. leading economic indicators rose 0.2% in May, following 0.4% increases in March and April. The lower reading for May could be temporary, but even so it suggests continued growth for the rest of 2018. Unemployment continues to drop, leading most economists to predict stronger wage increases in the near future. The “hot button” issue for the near future will be the potential for a trade war between the U.S. and its major trading partners. Details in several key areas follow below.
Consumers – The consumer sector showed continuing strength in the first half of 2018. The Federal Reserve reported that U.S. household net worth increased to a record $98.75 Trillion in Q4 2017. Unemployment continued to decline over the first half of 2018 to 3.8%. This latest reading is at an 18 year low. Hourly wages are accelerating, but only slightly, up 2.7% over the past 12 months. The only negative is the decline in the labor participation rate to 62.7%. Housing remains strong, as the S&P Case-Shiller index was up 6.4% for the year in April. The Conference Board’s Consumer Confidence Index dropped slightly to 126.4 in June, from 128.8 in May, but it remains near an 18-year high.
Businesses – Business conditions continue to improve and the outlook is increasingly optimistic. According to Factset, Q2 2018 earnings for the S&P 500 are forecast to increase by 20% year-over-year. This would be the second fastest earnings growth rate since Q3, 2010. The U.S. Institute for Supply Management manufacturing index increased modestly to 60.2% in June, from 58.7 in May. Similarly, the ISM services index increased to 58.6 in May, from 56.8 in April. Measures above 50% indicate expansion for both indexes. Continued growth will hinge upon the outcome of trade negotiations (or lack thereof).
Government – On February 5, Jerome Powell replaced Janet Yellen as Chair of the Federal Reserve. So far, he seems to be adhering to Yellen’s plan to cautiously raise the Fed funds rate. Inflation has now just reached the Fed’s long-run 2% target. The Fed raised its benchmark lending rate for the seventh time since beginning in December 2015, to a range of 1.75% – 2.0% (still historically very low). If the economy continues to perform as expected, the Fed is expected to announce two additional rate increases in 2018.
International – The International Monetary Fund’s (IMF) latest World Economic Outlook again revised its forecasts for global economic growth slightly upward. The current forecast is for growth to increase to 3.9% for fiscal 2018 and 2019. Upward revisions were largest for the euro area, Japan, China and the U.S. Several developing economies are also expected to show improved growth. The IMF release stated: “Growth this broad based and strong has not been seen since the world’s initial sharp 2010 bounce back from the financial crisis of 2008–09.” However, two major risks to growth are apparent – the potential slowing effect of tighter U.S. monetary policy, and the even more threatening effects of an all-out trade war between the U.S. and all of its major trade partners. The Trump administration has imposed a series of tariffs on goods imported to the U.S. and our trade partners have begun to retaliate. Whether this is fairly temporary, and part of the Trump administration’s bargaining process, or the beginning of long-term trade restrictions remains to be seen. Until uncertainty is resolved, expect to see increased market volatility.
Closing – Both the U.S. and global economies are growing at an increased pace. The impact of the Tax Cuts and Jobs act will be positive for growth, but the effects of possible long-run trade restrictions are uncertain. The impact of Fed policy (number and size of rate increases) will also play a major role in economic growth going forward. Surprisingly tensions with North Korea have eased considerably, however, activity in Iran and Syria cloud the global economic picture.