Quarterly Market Update
Stalled U.S. Economic Growth Continues to Perplex
GDP Growth Stall Continues
Second-quarter U.S. economic growth was more sluggish than initially thought. The Commerce Department revised the initial GDP growth estimate of 1.2% down to 1.1%. The economy grew at a rate of only 0.80% in the first quarter, bringing the 2016 first-half average to an inflation-adjusted rate of 1.0%, the slowest six-month growth rate since 2012. Previous 2016 GDP estimates of around 2.0% have been lowered to 1.8%.
Despite massive stimulus, the economy has grown at a rate of only 2.1% since the U.S. recovery began in 2009, the slowest pace of any recovery in the post-World War II era. Theories to explain the sluggish pace abound. Some theories point to consumers and businesses – consumers are saving more and spending less, the country’s aging demographics have changed spending and investing patterns, and while corporations have taken advantage of low interest rates to issue debt, many have used the cash for stock buy-back programs rather than new business investment. Other theories place the blame on the federal government – the lack of fiscal stimulus, increased regulation like Obamacare, the Dodd-Frank financial regulation bill, and stricter environmental regulations. And finally, some pundits blame the problem on technology – technological advancement has resulted in profound gains in efficiency, but perhaps at the expense of well-paying jobs. Whatever the culprit (likely a combination of factors), businesses and consumers are being forced to adapt to the phenomenon and contemplate the prospect of slow growth (e.g., 1.5% to 2.5%) perhaps becoming the “new normal”.
The initial non-farm payroll figures for September showed that 156,000 jobs were added, the smallest gain since May. The report also revised figures for prior months – the economy added 167,000 jobs in August, up from the previously reported 151,000 jobs and added 252,000 jobs in July, revised down from 275,000.
It would appear that the domestic economy has maxed out its ability to grow payrolls above the current modest pace. Job growth in the range of 150,000 to 200,000 per month seems attainable, but consistent monthly payroll gains above 250,000 appear unlikely over the near term. As of August, the unemployment rate has remained at 4.9% for three months in a row, but ticked up to 5.0% in September, a positive sign indicating that more workers are entering the marketplace. In yet another positive sign, growth in wages accelerated. Private sector wages increased to $25.79 per hour, up six cents, or .02% from August.
The labor force participation rate stood at 62.9% in September, up .01% from August and .05% from a year earlier. It is still hovering near the lowest level since the late 1970s, in part due to baby boomers’ retirement and the fact that many have given up on the job search. Driven largely by the addition of women in the workplace, the labor force participation rate increased from the late 1970s until the recession began in 2007 at which point the rate stood at 66.4%. The rate began to decline after the recession ended in June 2009 before reaching a low of 62.4% in September 2015.
Higher Oil Prices Could Stimulate Inflation
Inflation, now at 1.7%, remains below the 2.0% Fed target with no significant tailwind to push it higher. Wages are the number one contributor to inflation, but they are only modestly improved. The recent tentative OPEC agreement to cut oil production could bring supply more in line with demand, perhaps generating a bit of inflation. Energy inflation combined with the weakening of the U.S. dollar which typically accompanies an oil price increase would provide some economic stimulus. However, there appears to be a cap on how high oil prices can go before domestic production resumes, offsetting any drop in supply caused by OPEC. In the meantime, West Texas Intermediate Crude (WTI) oil prices appear to have rebounded from their low of $26 per barrel on February 11 while remaining in a range of $40 to $60 per barrel.
Manufacturing Expanded in September
The ISM manufacturing index contracted in August to 49.4 from 52.6 in July, but expanded to 51.5 in September as the overall economy grew for the 88th consecutive month, according to the September Manufacturing ISM Report On Business. Only seven of 18 industries reported economic growth, while 11 industries reported contraction. ISM®’s September New Orders Index registered 55.1 versus August 49.1, indicating growth in new orders following one month of contraction. The small rebound could be attributable to the bounce in oil prices and improvement in production and exploration activity.
Economic activity in the non- manufacturing, or services sector, recently saw its largest expansion rate of the year as the September report registered 57.1.
Retail Sales Projected to be Up for the Holidays
The Conference Board’s Consumer Confidence Index rose to 104.1 in September, its second consecutive increase, to its highest level since the recession. According to the report, consumers are more optimistic about the short-term employment outlook but are neutral regarding business conditions and income prospects. Despite the benefits of low inflation and energy costs, most retail sales were down in August. Department stores receipts were down 5% versus those of 2015. Automobile sales also slowed after a record sales year in 2015. Non-store retailers, including online sellers continued to gain strength, jumping 10.9% in August compared to 2015, albeit from a lower base than traditional retail stores. However, the National Retail Federation (NRF) recently forecast that holiday spending in brick and mortar stores will be up 3.6% this year, slightly about the 3.4% post- recession average experienced since 2009, and that non-store sales would increase between seven and 10%. The NRF also noted that consumer spending patterns are shifting from the accumulation of goods to a greater focus on services and experiences like entertainment, food, and travel.
U.S. Dollar Captive to Fed Moves
As investor expectations for a Fed rate hike diminished late in the quarter, the U.S. dollar sold off, and the WSJ Dollar Index ended the quarter down approximately 0.5%. The on-again, off-again stance of the Fed regarding what was originally forecast at the end of 2015 to be four rate hikes in 2016 has its roots in weak economic data and global turmoil, especially the unexpected vote in the U.K. to leave the European Union. The FOMC is very unlikely to hike rates in front of the November 8 national election. However, a 25 basis point increase in the Fed Funds Rate at the December FOMC meeting is more likely. The current probability of a December hike is 61%.
It is becoming increasingly difficult to identify the source of stalled U.S. economic growth or to predict the shot of adrenalin needed to kick start employment, inflation, and GDP growth. However, completion of the election in November could help matters regardless of the outcome. Investors and corporate executives responsible for capital spending both loathe uncertainty and a large amount of uncertainty will be removed once everyone knows who the new President will be and how Congress will be comprised. Those “known” will allow for longer-term decisions to be made and allow for perhaps greater commitment of resources that will stimulate growth. In addition, recent improvement in global economic data over the last few weeks, while modest, has become broader and more consistent, perhaps indicating acceleration in global growth is near.
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