About two weeks ago, we sent a “Market Update” to all our clients in the wake of back-to-back days of multiple hundreds of point drops in the Dow Jones Industrial Average (DJIA) and similar drops in the other major U.S. equity averages like the S&P 500 and the NASDAQ. We sent this update to help put in perspective the magnitude of the current market volatility and to briefly discuss why this volatility is occurring.
We want to again address this topic because the U.S. equity markets continue to trend downwards and with heightened volatility. Indeed, for much of December, the 3 major U.S. equity indices (as listed above) have been trading in correction territory. In other words, they have been trading 10% or more below the all-time highs they each reached earlier this year (in late September and early October).
As you might expect, we have talked with a number of our clients over the last month. Many of these calls and meetings related, at least in part, to the concern or anxiety some are feeling about the U.S. financial markets right now and what this volatility might portend for 2019. While we do not have a crystal ball and are not able to predict with any guaranteed degree of certainty what will happen in 2019, we continue to believe that the current financial market volatility is not suggestive of an impending recession. Rather, we believe the market volatility of late is a natural byproduct of the U.S. and global financial markets grappling with the end of highly accommodative monetary policies and the return to a more “normal” interest rate environment. We think this volatility is also a reaction to some of the global economic uncertainties related to the ongoing trade dispute between the U.S. and China and the impending Brexit.
For the last few years, many of the world economies steadily moved forward together, thanks, in part, to coordinated and accommodative central bank efforts in Europe and Asia (and previously in the U.S.). According to the International Monetary Fund (IMF), global GDP growth for 2017 was a healthy 3.7%. While this synchronized and robust global growth was a positive to the world’s economies, the concern now is that the global economy will soon experience a synchronized economic slowdown. Less accommodative monetary policies along with the trade disputes and Brexit top the list of reasons why the global economy could slow. For now, however, the IMF predicts global GDP growth will remain at 3.7% for both 2018 and 2019. https://www.imf.org/en/Publications/WEO/Issues/2018/09/24/world-economic-outlook-october-2018#Full%20Report. Despite similar concerns about the U.S. economy, The Conference Board predicts annual GDP growth will be 2.9% for both 2018 and 2019 and then will slow to 2.2% for 2020. https://www.conference-board.org/data/usforecast.cfm. The Conference Board’s Leading Economic Index (“LEI”) also rose slightly in November as you can see in the chart:
The LEI measures the rate of change in 10 key leading economic data points such as building permits, consumer confidence, unemployment, and new orders for consumer goods and materials. It is a good measure of the expected future health of the U.S. economy. At present, the broad strength recently evidenced in most of the 10 economic data points suggests the U.S. economy will continue to support economic growth in excess of 2% in 2019 and possibly in 2020 as well. The Federal Reserve, in its December 19th press release announcing its last 25 basis point fed funds rate increase for 2018, also noted the U.S. economy continues to be robust:
Information received since the Federal Open Market Committee met in November indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate. Job gains have been strong, on average, in recent months, and the unemployment rate has remained low. Household spending has continued to grow strongly, while growth of business fixed investment has moderated from its rapid pace earlier in the year. On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.
Despite the investor angst that is partially caused by the recent market volatility, the U.S. economy appears poised to remain on its path of reasonably paced economic growth in 2019 and possibly beyond. Admittedly, the pace of growth may gradually slow later in 2019 and into 2020, but, that is to be expected given the Federal Reserve’s two-pronged effort to control inflation, reduce its balance sheet, and return the economy to a more “normal” interest rate environment. The Fed is simultaneously raising interest rates in small increments (0.25% at a time) and very gradually reducing its balance sheet by decreasing its reinvestment of the proceeds it receives as the bonds it owns come due. The U.S. economy must also grapple with a tight labor market, very low unemployment and a marked lack of available skilled workers, the eventual economic ramifications of higher tariffs and the ongoing trade dispute with China, and several geo-political uncertainties including Brexit. There is certainly no shortage of challenging geo-political and economic issues at the moment!
Despite these issues, the U.S. economy continues to exhibit its resilience. The Consumer
Confidence Index pulled back slightly in November but remains at a historically high level. Also, as noted above, the LEI rose 0.2% and exhibited broad-based strength. Inflation continues to hover relatively close to the Federal Reserve’s target of 2%, unemployment remains at a 48-year low, job growth is strong, and wages are continuing to rise. Most U.S. consumers are employed and earning more now than they did a year or two ago. This bodes well for the U.S. economy in 2019 because U.S. consumers are a key driver of economic activity.
While we feel fairly positive about 2019, we recognize that economic and geo-political conditions can change unexpectedly. We also recognize that excessive volatility – especially in conjunction with a seemingly never-ending stream of alarmist news stories – can unnerve and unnecessarily worry and confuse investors. Please, do not ever hesitate to call or email your team at BLB&B Advisors if you are concerned. Also, please keep in mind that when we build and manage portfolios we take into account that economies ebb and flow, that geo-political events may arise at any time, and that volatility occasionally spikes and investors sometimes panic. Portfolio diversification can help to soften the blow in difficult financial markets. Similarly, maintaining investment discipline and resisting the urge to “sell everything” also generally pays off big over the longer haul.