A “Goldilocks” Economy For Now

March 15th, 2019 by Jonathan Chatfield, CFA

At this juncture we seem to be in a “Goldilocks” economy – not too hot, not too cold.  While economic growth continued at a more robust pace in 2018, as the benefit of lower tax withholdings on employee wages resulted in increased consumer spending throughout the year, it has now moderated, easing pressure on the Fed. Meanwhile, inflation remains tame and interest rates, which were on the rise, have settled in the wake of a pause in the Fed’s tightening policy and reassuring comments from Fed Chairman Powell.

Economic Growth Moderating means less pressure on the Fed to tighten rates.
The Bureau of Economic Analysis reported GDP growth of 2.6% in the fourth quarter, beating the consensus forecast of 2.2%. This follows a rise of 3.4% in the prior quarter.1 Moderating economic growth means less pressure on the Fed to raise rates and slow the economy to stave off inflation.

Inflation remains below the Fed’s rate target. The PCE price index, ex-food and energy, increased 1.7% in the fourth quarter, compared with a rise of 1.6% in the third quarter.1 The Fed’s target rate, adopted in 2012 under the leadership of Chairman Bernanke, is 2%. 2

The labor market is in very good shape. The national unemployment rate fell to 3.8% in February, versus 4% in January and better than forecasts of 3.9%. Since 1948 the all-time high was 10.8%, reached in November of 1982; and the all-time low was 2.5%, in May 1953.3 A robust economy has created jobs and fueled prosperity.

Stating “Participants pointed to a variety of considerations that supported a patient approach to monetary policy at this juncture as an appropriate step in managing various risks and uncertainties in the outlook” at its January meeting, the Fed has paused its “policy normalization” process, or current rate tightening cycle, which began in December 2015. Its last rate increase was in December 2018, when it raised its target range for the benchmark rate to 2.25% – 2.5% and forecast two hikes in 2019. That was its fourth rate increase in 2018 and the ninth of the current cycle.4 With the pace of inflation remaining low and GDP growth having moderated, we believe the chances of a longer pause in the pace of interest rate increases have improved, supporting continued economic growth and a favorable climate for continued stock market gains.

Fourth quarter earnings gains
With 96% of S&P 500 companies having reported as of March 7, 4th quarter earnings are estimated at $28.72, an increase of 6.5% quarter-over-quarter. For the year, projected earnings of $132.15 increased 20% on a year-over-year basis 6.

Economic results, growth of earnings and the Fed’s interest rate policy moves have propelled stocks dramatically higher thus far in 2019. After the disastrous month of December during which the S&P 5007 was down 9%, stocks have rebounded strongly, with the S&P 500 up 11.48% 8 (1/1/18 – 2/28/18).

In this favorable environment for equities, and with increased yield available from the bond market after last year’s rate hikes, we will continue to be diligent in our portfolio management process. We emphasize companies that meet our criteria based on financial strength, dividend growth and sustainability at a good value and adjusting our bond exposure based on our outlook for interest rates in the near- and intermediate term.

  1. https://www.bea.gov/news/2019/initial-gross-domestic-product-4th-quarter-and-annual-2018
  2. https://www.brookings.edu/research/alternatives-to-the-feds-2-percent-inflation-target/
  3. https://tradingeconomics.com/united-states/unemployment-rate
  4. https://www.cnbc.com/2018/12/19/fed-hikes-rates-by-a-quarter-point-.html
  5. https://www.cnbc.com/2019/02/20/the-fed-just-released-minutes-from-its-market-moving-meeting.html
  6. https://us.spindices.com/documents/additional-material/sp-500-eps-est.xlsx
  7. The S&P 500 Total Return Index
  8. https://us.spindices.com/indices/equity/sp-500