Should we be concerned about the U.S. economy?
With equity markets continuously hitting alltime highs this year, we frequently get the question from our clients as to when will the bull market end. The level of skepticism remains high even as the S&P 500 Index crossed four major milestones this year, passing the 2,300 level in February and recently crossing the 2,600 level. With that said, it is understandable that investors would question equity markets at these levels since it has been almost two years since the last 10 percent correction and nine years since the last bear market environment. However, when trying to predict the next major market downturn, we believe it is important to focus on economic fundamentals rather than excessive valuations or the length of time from the last correction. From a historical perspective, bear markets (i.e. decline of 20 percent or more) tend to be caused by economic recessions rather than excessive valuations. Therefore, the more appropriate question investors should be asking is “is the U.S. economy heading towards a recession?” We believe the answer is no, at least not in the foreseeable future.
The lynchpin to our economic forecast is based on strength in the labor market, coupled with an improving global economic environment. Unemployment here in the U.S. remains near a ten-year low, while wage growth has begun to pick up. Rising wages helps consumption, which accounts for approximately 70 percent of U.S. GDP. With consumer spending near all-time highs, GDP has grown at or near 3 percent for the past three quarters (including the current quarter), which is the best rate of growth since 2014. Furthermore, business investment has picked up this year which may help to further drive GDP growth into 2018. Global economies are experiencing their best annual growth rate since 2011, with many Wall Street economists now predicting 4 percent GDP growth in 2018. This is important to the U.S. economy, since S&P 500 companies generate more than 40 percent of their revenue abroad. Inflation remains below the Federal Reserve’s stated target of 2 percent, while other indicators tied to housing and manufacturing all point towards an expanding economy
An indicator we are closely monitoring is a flattening yield curve, which means short term government bond yields are nearing longer term yields. An inverted yield curve, where short term yields are higher than long term yields, has predicated the last 5 recessions. Although a flattening yield curve is a cause for concern, it does not signal a recession in the next 1-2 years. We expect inflation to gradually pick up in 2018 as the U.S. and global economic environment continues to strengthen. This should push intermediateand long-term bond yields higher, despite short term rates increasing as the Fed normalizes their benchmark rate. Still, we expect yields to remain below historical averages, which allows for higher stock valuations. This, coupled with a potential cut in corporate taxes, would be beneficial to equity markets.
Although we are optimistic in our economic and market forecasts, investors should make sure they have the appropriate allocation between stocks and bonds to help manage risk during periods of unexpected volatility. For investors with liquidity needs, now may be a good time to take gains by selling into market strength to cover your cash flow needs.
Steven Bouchey CFP is president of Bouchey Financial Group, Ltd. with offices in Saratoga Springs and Historic Downtown Troy. E-mail investment and financial planning questions to planningpaysoff@bouchey.com. Information contained in this column should not be considered as the receipt of personalized financial advice and please consult with your financial advisor.