May 2017 Monthly Outlook

by on Jun 1, 2017 Categories: monthly outlook, us stock market, us economy

Economic Commentary:

The first half of 2017 is likely to close with a flourish. Growth should rebound this quarter following a slow first quarter in which the economy—under duress from weakening demand for autos, a falloff in usage at the nation’s utilities (due to unseasonably warm weather), a downturn in defense expenditures, and a slowdown in inventory accumulation—expanded by a modest 1.2%. Overall, the U.S. gross domestic product is likely to advance about 3% in the current period. In part, this sequence is an annual event. That is, seasonal weakness is suffered early and is then followed by an acceleration in activity during the spring. Of course, seasonality is just part of the story. Other factors in the likely jump in second-quarter GDP figure to be a rise in household spending, higher incomes, strength in employment, further durability in homebuilding, accelerating increases in industrial production, and asset appreciation (from rising home prices and a higher stock market so far this year). A probable rebuilding of inventories also should contribute to the fast close to the first half of 2017. 

The Conference Board Leading Economic Index® (LEI) for the U.S. increased 0.3% in April to 126.9, following a 0.3% increase in March.  “The recent trend in the U.S. LEI, led by the positive outlook of consumers and financial markets, continues to point to a growing economy, perhaps even a cyclical pickup,” said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. “First quarter’s weak GDP growth is likely a temporary hiccup as the economy returns to its long-term trend of about 2%. While the majority of leading indicators have been contributing positively in recent months, housing permits followed by average workweek in manufacturing have been the sources of weakness among the U.S. LEI components.” 

A theme of this durable, yet unprepossessing, economic expansion has been low inflation. In fact, the Federal Reserve’s Federal Open Market Committee has long noted that inflation has remained below the bank’s long-term target of 2%. But at the Fed’s May meeting, it intoned that it expected “inflation will stabilize around 2% over the medium term.” It observed, as well, that “inflation measured on a 12-month basis recently has been running close to the Committee’s 2% longer-run objective.” So, things may be evolving. In fact, after years in which plentiful productive capacity, soft commodity prices, slow wage growth, and relatively high unemployment kept inflation at bay, figures from the Labor Department signaled an upward turn in producer (wholesale) prices in April and a modest increase in consumer prices. The maturation of the business up cycle, more aggressive pricing in selective markets, steady wage gains, and near full-employment would appear to be contributing to this slow evolution in pricing.  

Indicators point to the U.S. economy accelerating in the short term and in the long term continuing a slow but steady growth rate  of ~2% annually.

Stock and Bond Market Commentary:

First quarter earnings season recently ended and was a stellar one, as about 75% of the companies in the S&P 500 beat the mean earnings estimate, while almost 65% of these companies exceeded targets on the revenue side. Overall, earnings were up better than 12% for the period, which was the highest earnings growth rate since the third quarter of 2011. For the second quarter, as is the normal pattern, more companies issued negative earnings guidance than positive guidance. If past is prologue, and given the improving business outlook, we should again see a solid profit showing by Corporate America. Earnings growth is expected to surpass 8% this year, a formidable increase, with an even better showing likely in 2018. Thereafter, as economic growth slows, so should earnings. For now, however, expectations of additional solid earnings growth are helping to sustain the bull market.

The U.S. stock market has been led higher year to date by the strong performance in the technology sector, the largest sector of the index. With the drop in oil prices, the energy index has lagged the market index significantly, dropping 12.6% YTD. The U.S. continues to increase energy production despite the drop in the commodity price, prolonging the recovery in this sector. After a strong fourth quarter of 2016, the financial sector has stumbled YTD with the second worst sector performance.

In the short term (1-3 years), until the Federal Reserve raises interest rates to a level that incentivizes investors to take less risk (vehicles like savings accounts, money markets, CD’s), investors will probably continue to put more funds into risky assets such as stocks and real estate pushing up the price levels and valuations on these asset classes. Over the longer term, investment in businesses (i.e. stocks) should provide superior returns to all other classes.

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