The Roots of Today’s Growth

Remember the global panic of early 2016? The recent economic growth and market strength had their roots there.

You might remember that in late 2015, investors started to see warning signs in China. China’s stock markets had a very strong 2015, largely because regulators had changed the rules to allow more leveraged investing. As 2015 became 2016, the markets went from extended into bubble territory.

The bubble burst. Once the markets began to fall, the leverage accelerated the decline. The rapid stock market decline, coupled with worse-than-expected economic data, raised concerns. Since China had propelled much of global growth since 2009, there were significant worries about the fate of the global economy.

Data from the United States and other developed nations also was below expectations. Fears rose that the global economy was on the verge of deflation, which could lead to a new depression. All markets began rapid declines, except government bond markets, which gained from a flight to safety.

Central banks responded with strong monetary and credit growth. Most measures of monetary policy showed sharp expansion in the early days of 2016 in what appeared to be a coordinated global policy.

The moves worked.

As you’re aware, global stock markets and commodity markets recovered. We’ve gone from talk of deflation to inflation rates nearing central bank targets and talk of reflation.

In late 2016, the Federal Reserve resumed the tightening it began in 2014, when it stopped quantitative easing, and made clear it plans to continue tightening through 2017. The European Central Bank continues its quantitative easing, but indicated it might shift to a neutral monetary policy in late 2017 or early 2018

It appears that in the United States and in emerging markets, economic activity has generated enough momentum that growth can continue with neutral or mild tightening of monetary policy.

I think markets don’t recognize the momentum in the global economy. They’re probably overestimating growth in the United States, but they are underestimating the likely growth in Europe, emerging markets and Japan. That’s where we’ve taken the bulk of our risk in the Retirement Watch portfolios, and it’s paid off.

Of course, we have to worry about what’s next.

The greatest risk, as I’ve said many times, is that central banks might tighten too much, too fast. That’s still possible, but public statements indicate the central bankers understand this risk and are determined to err on the side of too much easing rather than too much tightening.

Another risk is that the momentum isn’t as strong as it appears. Perhaps growth can’t be sustained in the face of mild tightening. I don’t think that’s the case, but a shock or shocks, combined with mild tightening, could derail economic growth. These potential risks are why we look for margins of safety in our investments and balance and diversification in our portfolios.

The Data

Manufacturing took a rest in the New York area. The Empire State Manufacturing Survey registered a negative 1.0 after several months of very strong results. Most analysts believe the slow down is welcome because the previous surveys were so strong that they were reporting backlogs and supply constraints with the potential to lead to overheating.

There was no rest in the Philadelphia area, according to the Philadelphia Fed Business Outlook Survey. It soared to 38.8 from 22.0. This is the second highest level since 1983, with the highest coming in February this year. The survey was so strong that manufacturing shows signs of overheating in the region.

Industrial Production finally delivered a number that matched the recent anecdotal surveys. Production increased 1%, and the manufacturing component also increased 1%. Those numbers are well above recent months and expectations. Positive results were widespread through the components of the report.

Housing delivered some mixed results.

The Housing Market Index from the National Association of Home Builders (NAHB) rose to 70 from 68. The components of the report were strong throughout. In recent months, the optimism of the NAHB members has been reflected in higher new home sales.

That made the Housing Permits and Starts report disappointing. The starts were less than last month and below expectations. The same goes for permits. The good news in the report was that single-family home starts rose 0.4%. Multifamily starts declined, holding down the headline number. But permits and completions for single-family homes each declined 4.5%. While this was a disappointing report, most other residential real estate data the last couple of months have been very positive.

Consumer Sentiment, as measured by the University of Michigan, rose to 97.7 from 97.0. The current conditions reading was steady, but expectations are substantially higher. The measure is back near its high of the recovery.

Retail sales recovered in April, rising 0.4% after declining 0.2% (revised higher to 0.1%) in March. Excluding autos and gas, the increase was 0.3%. Though an encouraging reversal, sales still were below expectations and aren’t matching the consumer sentiment surveys.

The Consumer Price Index continues its uneven climb. Last month the index increased 0.2%, rising 0.1% after excluding food and energy. It is up 2.2% over 12 months, and 1.9% after excluding food and energy. The latest month and last month were very modest increases and lower than just a few months ago. I think this is a temporary trend due to some short-term anomalies, especially in cellphone pricing. We’re not tipping back to a deflationary period, and inflation is likely to rise more than markets expect.

New unemployment claims declined another 4,000. Continuing claims are at a 29-year low, and the weekly and four-week average claims also are at multi-decade lows.

The Index of Leading Economic Indicators from The Conference Board continued a string of increases. This month the increase was 0.3%. The trend indicates economic growth should increase a bit the rest of this year.

The Markets

Stocks had positive returns for the week until Wednesday’s sharp decline. The S&P 500 lost 1.68% for the week ended with Wednesday’s close. The Dow Jones Industrial Average declined 1.46%. The Russell 2000 fell 3.09%. The All-Country World Index gave up 0.32%. Emerging market equities rose 1.38%.

Long-term treasuries gained 2.69%. Investment-grade bonds rose 1.58%. Treasury Inflation-Protected Securities (TIPS) rose 0.89%. High-yield bonds gained 0.25%.

The dollar tumbled 2.11%.

Energy-based commodities rose 2.26%. Broader-based commodities added 1.68%. Gold gained 2.89%.

Bob’s News & Updates

IRAs are among the most valuable assets that most people own. That’s why I recently conducted a webinar, IRA Changes & Strategies You MUST Know. It is one of my most popular and important presentations. Find out more here.

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