February 2018 Monthly Outlook

by on Mar 7, 2018 Categories: monthly outlook, us stock market, us economy

Economic Commentary

The latest estimate of Q4 real GDP came in at 2.5%, bringing total GDP for 2017 to 2.3% -— slightly higher than the 2.1% average the U.S. has experienced since the last recession in 2009. Employment has held up as the unemployment rate remains at 4.1%, just as it has the past 18-24 months. Inflation has stayed tepid at less than 2%, but the Fed is vigilant of a pickup in inflation as bank lending has increased.   

The Conference Board Leading Economic Index® (LEI) for the U.S. increased 1.0in January to 108.1 (2016 = 100), following a 0.6% increase in December, and a 0.4% increase in November. “The U.S. LEI accelerated further in January and continues to point to robust economic growth in the first half of 2018. While the recent stock market volatility will not be reflected in the U.S. LEI until next month, consumers’ and business’ outlook on the economy had been improving for several months and should not be greatly impacted,” said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. “The leading indicators reflect an economy with widespread strengths coming from financial conditions, manufacturing, residential construction, and labor markets.” 

Indicators point to the U.S. economy accelerating in the short term to around 3% annually from a long term rate of ~2% annually. We remain in the late stages of a long business up-cycle and are starting to see signs of major excesses that have brought down some prior economic upturns. We remain vigilant of inflation and the Fed Reserve rate increases in reaction to the inflation data.  

Stock and Bond Commentary

After the 7% increase in stocks during the first 3 weeks of 2018, we finally saw a correction of 10%, resulting in a 3.64% stock index decease in February. This pullback and the increase in earnings toward the end of 2017 makes the market valuation more attractive as the annualized earnings yield of the S&P 500 increased to 3.95% from 3.64% in January 

Long term rates continued their increase in February resulting in decreases for the Bond and Real Estate sectors. The expectation is that inflation will increase with the large increase of U.S. government borrowing (an expected $1 trillion more in 2018 than 2017). This increase in long term interest rates caused the bond index to drop 1.01% in February, and interest rate sensitive sectors such as real estate and utilities to drop over 6%. We have been managing our clients' portfolios in the past year to prepare for this inevitable rise in interest rates by shifting to sectors that will benefit most from the increases in economic growth and inflation.    

We continue to actively monitor market indicators for potential signs of a recession or market correction. As mentioned in previous months all 7 official U.S. recessions and 89% of U.S. stock bear markets were preceded by an inverted yield curve.  

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 putting more funds into riskier 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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