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How to Navigate the Two Faces of the Economy

Last update on: Jun 16 2020

The outlook for the economy and markets depends on what data are assessed. The consumer and household side of the economy can’t get much better. Indeed, consumer confidence remains near all-time highs and the optimism contributes to rising retail sales growth.

Retail sales are volatile from month to month, but the average over several months has been solid. The decline at the end of 2018 is a fading memory. The strong labor market is one reason consumers are confident and spending money. For workers, the labor market rarely has been better. There are substantially more job openings than people unemployed.

Wages and salaries continue to increase much faster than earlier in the economic recovery. The 12-month increase in average hourly earnings exceeded 3% for the first time in this recovery in August 2018 and has stayed near that pace, aside from a high of 3.40% in February 2019. Consumer confidence and spending also are backed by rising prices for stocks and homes.

Home prices maintained a 12-month increase above 5% every month from November 2012 until recently. Before adjusting for inflation, the Corelogic S&P Case-Shiller Home Price Index is well above its 2006 peak. Small business owners also remain positive.

The Small Business Optimism Index from the National Federation of Independent Business is below the record highs of 2018. But it is well above the recent low of late 2018 and is comfortably above the long-term average. Yet, not all the economic news is positive. T

he manufacturing surveys tumbled in the last few months and manufacturing data such as Industrial Production have been declining. Businesses are reducing their investments in plant and equipment after a surge following enactment of the 2017 tax law. A peak behind the headlines makes clear why the consumer and the service sector of the economy are doing well while other sectors are faltering.

Interest-rate sensitive sectors of the economy still are feeling the effects of the Federal Reserve’s interest rate increases in 2018. But the combination of trade conflicts and slowing growth outside the United States explain much of the weak data. Sectors and companies that depend primarily on exports are where we see the softest sales, production and job growth.

Europe and Japan have been especially weak in 2019 and are flirting with recessions. Even Germany, which for a long time led the European economy, has declined steadily in 2019. These factors make global business managers more cautious. Many are taking a wait-and-see approach before committing to new investments or expansion plans. Surveys of large company leaders are significantly less positive than the small business and consumer surveys.

The good news for investors is that stock prices have factored in the lower earnings growth we began anticipating last year and still are experiencing. The potential bad news is that investors are expecting significant interest rate reductions from the Fed in 2019. Those also are factored into stock prices. If the Fed disappoints investors, stock prices are likely to tumble.

Stock buybacks have been a major support for stock prices the last few years. Investors reduced holdings of equity mutual funds and exchange-traded funds (ETFs). Corporations filled the gap with stock repurchases. After hitting a record high in the last quarter of 2018, stock repurchases declined for the first time in seven quarters in the first quarter of 2019. Corporations are conserving cash and seem less inclined to continue high levels of repurchases.

We’ve had warnings of reduced stock buybacks at other times in this bull market. Those warnings proved to be premature. If the warnings are prescient this time, stock prices will lose a major support. This isn’t the time to make major bets in your portfolio. Maintain diversification and balance and have a margin of safety in each of your investments.

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