At 117 months, the current economic expansion is only 3 months shy of becoming the longest expansionary cycle in U.S. history. By comparison, the average duration of an expansionary period is 67 months. While likely to surpass the previous record, the cur-rent expansion is also showing signs of aging, as late-cycle deceleration characteristics have become more prevalent. While the adage, “all good things must come to an end,” may seem relevant as we assess the current economic environment, it’s not necessarily the case that this expansion’s end is on the near-term horizon.
“At 117 months, the current economic expansion is only 3 months shy of becoming the longest expansionary cycle in U.S. history.”
In 2018, real domestic US GDP grew at an overall rate of 3%, although the second half of the year exhibited a deceleration trend that is likely to continue throughout 2019. In March, the U.S. government revised downward its 4th quarter economic growth estimate from 2.6% to 2.2%, vs. third quarter’s 3.4% growth rate. According to J.P. Morgan, US GDP growth is likely to slide back into the 2% range that we experienced earlier in the expansion. While we don’t generally prefer to see GDP growth decline, we believe the expectation of 2% growth appears realistic and indicates the current expansion does still have some life left in it.
Corporate proﬁt growth has declined and is not expected to return to 2017 levels any-time soon. In Q4 2018, year-over-year corporate earnings growth was up only 3%, vs. 32% in Q3. Although this sharp decline somewhat reﬂects a decelerating late-stage expansion, the degree of decline was somewhat surprising. That being said, we believe corporate earnings are expected to continue to experience single-digit proﬁt growth throughout the remainder of 2019. These estimates are based on stable, yet modest, GDP growth expectations, coupled with the fading eﬀects of the 2017 tax cuts, and higher costs related to interest, materials, and wages.
The employment situation is softening though unemployment is sitting at historic lows. As of February, the unemployment rate hit 3.8%, well below the 50-year average of 6.2%, and on it’s way to levels not seen since the early 1950s. Employment growth averaged 180 thousand jobs per month in the ﬁrst quarter of 2019, compared with 223 thousand in 2018. Although low unemployment does typically precede the end of an expansionary period, the fact that the rate continues to fall, signals that this cycle may still have more room to run. The tight labor market resulted in year-over-year wage growth of 3.5% as of February. Alt-hough many thought wage growth would have accelerated more at this point in the cycle, we believe recent in-creases should continue as the labor market rolls along at “full-employment.”
Despite 10+ years of monetary stimulus, economic growth and declining unemployment, there has been little meaningful increase in consumer prices. The Consumer Price Index (CPI) rose 0.4% in March, matching consensus expectations, up 1.9% from a year ago. Energy prices rose 3.5% in March, while food prices rose 0.3%. The “core” CPI excludes food and energy and increased only 0.1% in March, below expectations of 0.2%, up 2.0% versus a year ago. As wage growth continues to lag employment growth, we believe overall inﬂation is expected to be somewhat modest in 2019.
These muted levels of inﬂation have also played a role in monetary policy, as evidenced by the Federal Reserve’s decision to not raise rates over the past two quarters. At the moment, the Fed has put a hold on recent rate-hike implementations and has indicated that it intends to normalize its balance sheet by year-end. A combination of persistently low inﬂation, coupled with decelerating U.S. growth, has reduced the urgent need to increase rates further. While not likely to cause an overall spike in growth prospects, these actions could enable the economy to continue growing a little longer than anticipated, albeit at a modest and gradually declining rate.
The Treasury yield curve ﬂattened again during Q1 with yields on short term maturities staying relatively stable and yields on intermediate maturities falling. On March 22nd the yield on the 10-year U.S. Treasury Note fell below 3-month yields for the ﬁrst time this cycle. This phenomenon is known as an “inverted yield-curve,” and is typically a good leading economic indicator of impending recessionary cycles. Over the past 50 years, a recession has followed all but one instance of an inverted yield curve. That being said, the timing from initial inversion to recession has ranged from a few months to two years.
From an international perspective, the pace of global expansion has steadily declined over the past year, and some economists believe it is past its peak for this cycle. Political turmoil in France and Italy, weak manufacturing trends in Germany, and the now infamous Brexit debacle have led to economic anxiety across the Eurozone. The European Central Bank has again loosened its monetary policy in an eﬀort to stimulate growth. Additionally, uncertainty regarding the U.S./China trade war has caused an overall reduction in global trade and a decline in manufacturing activity for nations like Japan, Korea and Taiwan.
Despite a rough end to 2018 with a nearly 15% decline in the S&P in the 4th quarter, U.S. equities did an about-face during Q1 2019 and the S&P 500 roared back with a 13.7% gain. Valuations, measured by the Price to Earnings ratio have increased and are hovering around historical averages. Although the global economy is cooling oﬀ and corporate proﬁts are exhibiting decelerating growth trends, the bounce back in 1Q19 implies that investor sentiment and reaction in Q4 2018, may have been exaggerated. Of the 10 primary economic sectors, all experienced signiﬁcant gains in 1st quarter. Information Tech, Industrials, and Energy led the way with returns of 19.9%, 17.2% and 16.4% respectively. Healthcare, Financials, & Materials lagged in relative performance, though all posted positive returns. REITs also posted impressive gains during the quarter, with the Dow Jones US Real Estate index surging 17.1%.
International equities also experienced a nice turnaround from 2018 and delivered generally positive results, though somewhat short of US equities. In Q1 2019, the MSCI EAFE index, an index of developed international countries, gained 10.0%. Emerging markets were close behind with a quarterly return of just under 10%. In 2018, international equities grappled with a strong U.S. dollar, slower global growth, and investor caution surrounding the impact of the US/China trade war. Economic growth continues to lag the US and the Eurozone is trying to ﬁgure out the details of the “Brexit”. However, a combination of supportive monetary policies in Europe and China, as well as decreased perceptions of geopolitical risk surrounding the U.S./China trade dispute, seem to have buoyed investor sentiment as of late. That being said, it’s worth noting that the vast majority of international countries are more vulnerable to economic shocks from geopolitical risk than is the U.S., which makes those markets slightly more volatile given the current environment. That said, international stocks are relatively cheaper than domestic stocks, with emerging markets beneﬁting from a pause in U.S. interest rate increases having the most favorable long-term growth prospects.
In the ﬁxed income markets, recent monetary policy shifts coupled falling yields and a modest equity outlook, have been favorable to bond returns. Total returns across the ﬁxed income segments were positive in Q1. Bloomberg Bar-clays US Aggregate Bond Index returned 2.9% in the 1st quarter. Intermediate term government bonds, as measured by the Bloomberg Barclays 5-7 year Treasury Index, grew by 2.2% and intermediate term corporate bonds posted returns of 5.4% in Q1. High Yield securities, which tend to follow the performance of equities, climbed 7.3%, while Municipals were up 2.9%. Emerging market bonds made a robust recovery and delivered strong gains as well, end-ing the quarter up 6.6%. As of March 31st, 10-year Treasury yields were still well below their 50-year averages, imply-ing that there may still yet be a need for further rate increases prior to the end of this cycle. Although the current market environment is typically more favorable for stocks, core ﬁxed income still plays a critical role in a welldiversiﬁed portfolio
Despite the potential looming geopolitical risks associated with Brexit and the U.S./China trade dispute, the global outlook for 2019 is characterized by a somewhat tempered optimism. While it’s true that global growth has softened, tightening ﬁnancial policies appear to have temporarily retreated. Coupled with expansionary policy initiatives in China and Europe, global GDP growth for 2019 is still expected to land around 3%.
In the U.S., the expansion continues on and will likely become the longest on record this summer. The rate of growth is likely to be moderate and the recent deceleration in job growth and corporate proﬁts indicate that future economic gains will be more muted. However, a tight labor market and the Federal Reserve’s decision to hold oﬀ on additional rate increases should moderate decelerating growth trends for the remainder of the year and push the next economic downturn out a few more quarters. Earnings growth expectations are likely to continue to be tempered as domestic companies progress deeper into a late-stage expansion.
From an equity market perspective, there are many reasons to be cautiously optimistic. The ongoing expansion and favorable monetary policy are positives, yet equity fundamentals and valuations are less attractive than at the start of 2019. The strong ﬁrst quarter has moved market prices to more appropriate levels, which leaves less room for large growth opportunities. Additionally, we’re starting to see earnings downgrades outnumber upgrades on a more regular basis. While earnings growth expectations are still positive for the remainder of 2019, we believe growth rates are unlikely to break out of single-digit territory anytime soon.
We believe bond markets should remain stable, as subdued global growth and inﬂation is unlikely to provoke a reversal of dovish monetary policies. If these trends continue, we should see a modest steepening of the U.S. yield-curve throughout the year, pushing oﬀ a more pronounced inversion to a later stage of the cycle.
Maintaining a disciplined long-term approach to investing is always critical. That being said, due to the increase in volatility we have seen and the late-cycle economic stage we are in, there are strategic tactical shifts you can make to take some risk oﬀ the table in order to build a more resilient and defensive portfolio. A thoughtful, well diversiﬁed approach, including alternative and defensive strategies, should help alleviate investor anxiety and reduce the urge to panic. Consider meeting with your advisor to review your current risk tolerance and ensure your investments and ﬁnancial strategies are meeting your short term and long-term goals.
Kristofer R. Gray, CFP®, CRPS, C(k)P®, MPA
Chief Investment Oﬃcer
VP of Strategy
Sources: 1) American Funds – US Economic Outlook; 2) BlackRock—Global Inv. Outlook 2019 Q2; 3) BlackRock Benchmark Returns – March 2019; 4) JP Morgan Chase – Economic Update & Guide to the Markets – 2q19; 5) Envestnet PMC – Weekly Market Review; 6) Envestnet PMC – Economic and Market Overview, First Quarter 2019; 7) Nasdaq.com; 8) Bloomberg.com; 9) Goldman Sachs – Market Pulse
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