When you think back to December 2018, the financial markets were in disarray. Global investors were scared by uncertain monetary policy, fiscal and legislative discord, slowing economic growth, and slackening corporate profits.
Fortunately, the worst of these fears did not materialize. The U.S. economy avoided a recession, global equities rebounded, and fixed income returns contributed to diversified portfolios. Economic and market fundamentals were the foundation for the market’s recovery from the December lows. Even as we face prospects for periodic volatility, emphasizing
fundamentals remains critical for making effective decisions when investing in markets or your business.
At the halfway point of 2019, the U.S. economy has held steady, supported by the fiscal stimulus we have highlighted for two years, and corporate profits continue to grow. At the same time, trade tensions
2019 are increasingly weighing on the economic outlook, while slowing global growth and political uncertainty have forced global central bankers to extend extraordinary levels of support.
We are still navigating a challenging environment. Investing comes with uncertainty, and market volatility can be alarming, but investors should look beyond short-term market stresses and consider the real drivers of investment returns. That mindset may be a key to achieving long-term financial goals.
Following are updated views of current fundamentals and the things that should persist as shorter-term concerns fade. In this article, we focus on two of the four pillars for fundamental investing in one’s business or securities markets – policy and the economy.
Policy
Fiscal stimulus from the Tax Cuts and Jobs Act of 2017, along with decreased regulation and increased government spending, will continue to support the U.S. economy in 2019. The potential impact is both larger and more durable than consensus expectations. At the same time, uncertainty around global trade continues to dampen the benefits of fiscal support and may be discouraging productivity-enhancing capital investment. Self-interest is likely to bring the United States and China back to the negotiating table, but until there is progress, trade tensions remain the primary risk to forecasts.
While fiscal policy has taken the lead, monetary policy grew more supportive in the first half of 2019. The Federal Reserve (Fed) indicated earlier this year that it would likely hold on raising interest rates for the rest of 2019, partly in response to the market’s poor reaction to December’s rate increase. With inflation low, global growth slowing, and trade risk still present, monetary policy may be too tight for the current environment. Even if not fully justified by the data, the Fed may choose to lower rates later this year to provide a buffer against increased uncertainty.
Economy
Domestic: U.S. economic growth in the first quarter was better than expected, with early readings showing gross domestic product (GDP) growth of 3.1 percent. Data have weakened in the second quarter, but bright spots remain. Supported by strong labor markets, consumer sentiment remains upbeat, and consumer spending continues to be an important driver of growth; manufacturing, however, has seen a larger negative impact from trade. Fundamentals are supportive of moderate GDP growth this year. Again, progress on trade concerns is central to our growth projections, so GDP is forecasted to decrease 2.25–2.5 percent.
Inflation: The current pace of growth is consistent with an economy that is able to generate solid demand without adding excessive pricing pressures. Consumer inflation has slipped as global demand has softened, outweighing any broader price impact from tariffs. While headline inflation data remain sluggish, wages and wholesale prices continue to grow at a healthy clip. The Consumer Price Index (CPI), which excludes food and energy prices, is projected to grow 2–2.25 percent year over year in 2019, on pace with what it did in 2018.
Employment: Hiring has continued at an above-average pace for the expansion, with employment growth averaging around 200,000 jobs per month. Weekly claims for unemployment benefits have dropped to cycle lows several times this year, and this tight labor market will likely lead to increased wage growth in the coming months. Wages represent the largest cost for businesses, and it is difficult to have a sustainable inflation threat if wages are not climbing at a fast rate. Currently, wage growth is just above 3 percent, suggesting hourly earnings are not yet a threat to the economy.
Even though the economic environment has become more challenging, the pillars of fundamental investing – policy, economy, fixed income, and equities – still appear sound.
Global Economy
Even if revised downward, U.S. growth expectations have been holding up relatively well compared with global growth prospects. While trade-related tensions have had some impact on global growth, we believe the repercussions have been small to date, and that structural issues abroad have been the main culprit in the global slowdown.
Emerging markets (EM) will continue to lead developed markets in economic growth given the challenges in developed markets. Europe in particular still faces a variety of political and economic challenges. The United Kingdom’s Brexit process, messy from the start, continues to unravel; France is contending with the “yellow vest” protests; Germany is battling weaker manufacturing; and Italy is struggling with the difficult budget negotiations of an unsettled governing coalition. Trade concerns also remain in play for Europe, with important trade discussions with the United States on agriculture and autos still outstanding. These structural issues also have impacted the monetary policy outlook, with the European Central Bank (ECB) pushing back plans to raise rates and reduce the size of the ECB’s balance sheet.
In Japan, programs to increase government spending and reduce rates have supported growth. However, true structural reforms remain elusive. Consumer sentiment has also weakened ahead of the value-added tax (VAT) increase scheduled for the fourth quarter of 2019. Though Japan’s recent GDP growth has exceeded expectations, higher activity will likely come at the expense of growth in subsequent quarters.
Emerging markets likely will set the pace for global GDP. Beijing’s intervention has stabilized demand in China, but trade uncertainty continues to weigh on confidence and investment, suggesting the possibility for further stimulus. These policy efforts should support export growth in the rest of emerging Asia. In India, GDP growth will likely outpace the rest of EM during the next few years, even as stimulus wanes following the Indian elections. Growth in emerging Europe remains weak, indicating the need for central bank accommodation in Turkey and Russia. Mexico will continue to lead growth in Latin America, as Brazil struggles to gain traction.
The United States remains a growth leader in the developed world, but emerging markets continue to play an increasing role in the global economy, with the pace of growth leadership shifting from China to India.
Conclusion
Even though the economic environment has become more challenging, the pillars of fundamental investing – policy, economy, fixed income, and equities – still appear sound. For now, the odds of a near-term recession appear to remain low. U.S. stocks may endure periodic volatility as the bull market ages, but investors and business owners should focus on long-term trends instead of short-term noise. Volatility is the blessing – and curse – of long-term investing. During volatile periods, it can be tempting to make emotional, short-term decisions that could conflict with long-term goals. But we could also view bouts of volatility as opportunities. By focusing on the fundamentals, it is possible to make more prudent and effective decisions about how to achieve our long-term goals.
Jonathan Benner is a Certified Financial Planner™ with LPL Financial in Chesterfield, Missouri. He can be reached at jonathan.benner@lpl.com.