US Economy Raging?
"The economy is raging, at an all time high, and is set to get even better" according to President Trump.
This morning, US retail sales, as reported by the Commerce Department, notched their third consecutive month to month decline:
In the US, interest rates are rising and it is widely expected that they will be increased by another 1/4% next Wednesday following the US Federal Reserve's Federal Open Market Committee (FOMC) meeting to determine the course of monetary policy (and possibly another 2 or 3 times in 2018).
It is required of these folks to do this "in accordance with its mandate from congress to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy".
As we mentioned on our weekly video, the US economy is pretty close to full employment at 4.1% (latest data from last Friday).
Historically, just before a recession (blue shaded area), unemployment reaches its lowest point (top of the economic cycle). When it starts to move higher, intersects with the 3 year average and passes through it, a recession usually begins.
A client, obviously with way too much time on her/his hands (humour) actually watched our weekly video and asked for the "narrative" behind the statistical correlation, so here goes:
This situation tends to happen as a response to the US Fed raising interest rates, which is intended to slow the economy (and the prospect for future inflation) and which historically has lifted the unemployment rate.
In the current debt-laden (record household debt) economy, rising interest rates will increase the amount of money required to service that debt and give the consumer less purchasing power. The consumer is 2/3 of the US economy. Three months of declining retail sales may just be telling us about the state of 2/3 of the US economy (especially in light of the purported benefit of the US tax cut). When the consumer stops spending, inventories rise and businesses have to slow production. This increases the potential for layoffs and the possibility that unemployment rates will start to rise. Add in what also might be an unwanted impact (more unemployment) of protectionist trade policy. So we circle back to the history of unemployment rates and recessions.
As portfolio managers, we have to make some determinations as to how best allocate assets to our clients (and our) respective portfolios. We try to use a number these indicators of the state of the economy to get a handle on where we are in the economic cycle and by virtue of that, which assets might be vulnerable.
Historically, stock markets don't like recessions. As stocks have become relatively expensive over the last couple of years, they are likely to be more vulnerable, especially at this late stage of the cycle. That would indicate to us, as portfolio managers, that despite the emotionally charged equity market environment, being fully invested in equity assets may not be especially prudent.
As for the latest on the US economy in the 1st quarter of 2018 (following today's retail sales data): Growth is expected to be only +1.9%
Raging? I don't think so.
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