ECONOMIC/MARKET REPORT
ANALYTICAL CAPITAL
June 8 2018
ECONOMICS VS. POLITICS
Are U.S. economics all good for equities? Are politics all bad? Not exactly, but to a significant extent.
A potential trade war with China. The summit with North Korea on, off and on again. Tariffs on steel and aluminum imports – good for U.S. producers, bad for U.S. users. Our G-7 partners were happy with us in May, now they’re mad. Is NAFTA dead? Or maybe just half-dead? These vicissitudes have imposed a layer of market volatility and an accompanying increase in the equity risk premium (the extra return investors are rewarded with for accepting the risk of owning equities).
U.S. job creation, on the other hand, has been robust. Indeed, companies are reporting difficulty in filling open positions. The unemployment rate has fallen to 3.8%, the lowest rate since April 2000.¹ A broader measure, one including part-time workers who would prefer full time jobs, plus other job seekers not included in the headline number, has also fallen markedly. Anecdotal evidence of economic hardship has been replaced by newspaper articles describing worker shortages, particularly for skilled laborers.
Real GDP is growing nicely, albeit at a pace lower than history would suggest. The US economy expanded an annualized 2.2 percent during the first quarter of 2018 (3.2% has been the average since 1947, though this is not an altogether fair comparison).² Inflation remains contained, gratifyingly so at this stage of the business cycle, as a tight labor market usually spurs inflation.
Corporate profits – in our view the key long run factor in stock prices – remain healthy. Corporate profits in the United States increased by 5.9 percent in the first quarter of this year, a strong rebound from the 1.7% in the previous period. ³
Yes, interest rates have risen, and will likely continue to do so. We believe this is not such a bad thing. Rates have been unreasonably low for the better part of a decade. Our view is that a healthy economy calls for interest rates high enough to reward savers. Will the increase in rates reduce household and business spending? Perhaps, but the current environment of robust spending will only be marginally impacted. Overall, today’s rising rates are more of a sign of a healthy economy than a signal of trouble ahead.
With respect to stock prices, higher interest rates are a negative (via price-earnings multiples – a company’s future earnings are worth less when interest rates are higher, and so P-E ratios fall, causing stock prices to decline), all else the same. Interest rates become the key ingredient in equity valuations when the sequence of rate changes is erratic and outsized. We have not arrived at that point in this cycle.
As of now, we at Analytical Capital remain attracted to equities, because of strong corporate profits and prospects. When and if interest rates (and inflation) accelerate, we will reassess. That is, even if profits remain strong, should interest rates rise substantially, the relative attractiveness of fixed income investments will increase.
1. U.S. Bureau of Labor Statistics
2. U.S. Bureau of Economic Analysis
3. U.S. Bureau of Economic Analysis
Advisory services offered through Analytical Capital, a Member of Advisory Services Network, LLC.
All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed. All economic and performance data is historical and not indicative of future results. All views/opinions expressed herein are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC.
