Archive for GDP

Newsletter – April 2018

Posted by Koenig Investment on
 April 30, 2018
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Pausing to Smell the Roses

Economic news often looks towards the future as investors try to predict both the best places to invest and avoid.  Today’s successes are often overlooked as investors look for clear indicators of trends and future activity.  Sometimes it is best to stop and look at the current environment, appreciate what is going well, and wait to judge the future.  The overall U.S. economy is doing quite well at the moment and there is no reason to expect this to change in the near future. 

Earnings, GDP, PE

We are now well into 2018 first quarter earnings release season. The picture being painted is one of solid growth and earnings.  The earnings growth rate has been much higher than anticipated, with the highest earnings growth reported since the third quarter of 2010.1  In fact, one research service we use predicted an earnings growth rate of 17.3% for the quarter as late as April 6th.  This has now been revised upwards to 23.2%.1 

As earnings rise they change the price-earnings (PE) ratio for companies.  This ratio explores how long it would take an investor to recoup their principal based on current company earnings.  Low PE ratios mean investors can expect principal recovery much quicker, high PE ratios mean investors are paying a premium for stocks and can be an indicator of a bubble.  As you can see from the below chart, current PE ratios are right in line with the recent historical average.

SOURCE: Seeking Alpha3

Finally, GDP is a good indicator of the health of the economy as a whole.  2018 first quarter GDP stands at 2.3% versus 1.2% for the first quarter of 2017 and 0.6% for the first quarter of 2016.2  The first quarter tends to be the low figure for the year, so it can reasonably be expected that GDP will increase before the end of the year. 

The Rest of the Data

If the key metrics noted above are all positive, why the fear and worry in the news?  The first reason would be inevitability.  The stock market will eventually see a decline.  It goes through up and down cycles, meaning wait long enough and you will see prices fall.  One should pay attention to changes and not expect good times to last forever.  Let’s explore a few topics of worry in the news recently.  A good place to start is the slow ratcheting up of interest rates by the Fed. 

SOURCE:  MacroTrends4

The above graph is a chart of the 10-year Treasury rate over the past 50+ years (recessions noted in grey).  As you can see, we are currently in a period of historically low rates.  It’s also clear that we had higher rates in the 1990’s, a time of good performance by the stock market.  A rise in rates tends to slow housing sales and some business expansions as credit tightens.  However, these will be slow changes that are already widely expected and factoring into the decisions of families and companies.  Interest rate rises have been slow, and are expected to remain so.  Slow change allows for adjustment and is not the same as an unexpected market shock.  Interest rates are not expected to rise to a level that will prohibit borrowing, but rather to return to more historical norms.  This is good news for savers and an anticipated change for future borrowers.

Other articles point to a few large companies lowering guidance as a sign we’ve reached peak earnings.  It’s true that Caterpillar recently noted 2018 earnings may be their best and 2019 will likely be lower.  At the same time, Boeing both had good earnings and upwardly revised estimates through 2019.5  The fate of one company is not the fate of the economy as a whole.  Aggregate S&P 500 earnings estimates for 2019 have been revised upwards as companies release figures and give forward guidance.  That means companies generally do not see 2018 as a year of growth plateau, but rather as part of an upward trajectory that is expected to continue into 2019.

The last area of worry for some pundits is both wages and inflation.  We are seeing an uptick in both categories.  These are areas to watch for future developments that may provide drags on the economy.  We’re not there yet though.  Inflation remains at about 2.0%6 and wage growth is still at a lower rate than before the recession7.  Rising wage growth and inflation can be expected to limit the acceleration of economic growth, but are not expected to be a drag on the economy.

Summary

Some clients reading this may be wondering why their portfolios are not skyrocketing upwards given that the economy is doing well.  The stock market is considered a leading indicator and typically moves in advance of economic news.  The S&P 500 was up every month in 2017.  That is unusual.  Much of the good news noted above has already been priced into the market, allowing account values to increase in 2017.  The 2018 market is expected to increase more slowly, with more volatility than 2017.  Investors are looking to sell companies that have not benefited as much from economic growth, capture gains, and move on to other companies with rosier outlooks for the year.

The overall U.S. economy is doing quite well.  Persons looking for a job can probably find one with relative ease.  Borrowing costs remain historically low.  Companies are making money and looking to make more over the next year or so.  Of course, the market will eventually change and we will continue to watch for indicators of that change. 

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different.  The information provided is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties.  Individuals are encouraged to seek advice from their own tax or legal counsel.  Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.  Neither the information presented nor any opinion expressed constitutes a solicitation of the purchase or sale of any securities.

May 2015

Posted by Koenig Investment on
 May 11, 2015
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May 2015

Last year we wrote a newsletter that referred to the U.S. economy as a plow horse – slow, but getting the job done.  While some of the details have changed, the overall picture of the economy has not.  The U.S. has been seeing steady growth, with some quarters turning out more attractive numbers than others.  While most investors would like to see greater growth, slow and steady growth is not bad.  The broad market is at record highs, but is not excessively valued.  While analysts are not predicting high rates of return from the U.S. stock market, nor are they expecting significant drops.  The general consensus is that we continue to see slow, steady growth.

Gross Domestic Product (GDP)

2015 1st quarter GDP figures were low and caught most analysts by surprise.  However, this is a repeat of the previous year.  The winters of both 2013/2014 and 2014/2015 were unusually harsh in the Northeast United States.  Charts that break out GDP figures by sector show drops in consumer goods and services both winters. This, along with falling oil drilling activity, took a heavy economic toll in the 1st quarter of 2015.  Just as GDP rose for the rest of the year in 2014, we expect to see an increase in the 2nd quarter of 2015.  While GDP was a mere 0.2% for the 1st quarter of 2015, that is much better than the -2.1% drop seen last year at this time. GDP rebounded nicely in the 2nd and 3rd quarters of 2014, and we would expect a similar rebound this year.

2014 GDP:

Q1 2014 Q2 2014 Q3 2014 Q4 2014
-2.1% 4.6% 5.00% 2.2%

Source:  Bureau of Economic Analysis

We will not see uniform growth across all sectors.  For example, auto sales are expected to grow at 4-5% in 2015 compared to 10% in 2014.  More incentives, higher inventories, and loans as long as 7 years all suggest that auto sales are starting to slow.  However, pending home sales in 2015 are showing a sharp acceleration after a slow 2014, with homes sales up 11.1% year-over-year in March.  Homes sales tend to drive purchases of retail goods.  On the opposite end, the drop in oil prices has made exploration and drilling of new wells less attractive.  This is expected to result in lower purchasing levels of the heavy equipment used in the drilling industry.  Sectors seeing growth are expected to outweigh contracting sectors for the near future.

Inflation

Inflation is expected to remain at the low end of the average range (2-3%)1 for the near future.  There are several large and contradictory contributors to the rate that make it an interesting back and forth story.  Of course, the most dramatic recent contribution to lower inflation is the price of oil.  The Consumer Price Index dropped noticeably from November through January, leaving March with a -0.1% annual rate.2  The drop in both gasoline and fuel oil prices are clearly responsible for this negative index rate.  Food prices are up 2.3% from last year, medical care commodities are up 4.9%, and shelter is up 3.0%.  There are other sectors that saw falling prices (used cars and trucks, apparel, etc.), but these are quite modest declines in comparison the energy sector figures which posted a -29.2% annual drop in gasoline prices and a -24.9% annual drop in fuel oil prices as of March.

We see upward inflationary pressure in the economy as sectors deal with the legacy of the housing crisis.  The economy has been operating well below capacity (labor, capital & productivity) since 2008, which has held down inflation rates.  It was nearly impossible for any business to raise prices in 2009 (at the trough of the economy) for the fear a competitor with excess capacity would not raise their prices, thus gaining market share.

Unemployment Rates:

2012 2013 2014 2015 est.
7.9% 6.7% 5.6% 5% – 5.5%

Source:  Morningstar Estimates

Excess capacity has shrunk considerably in 2015, due in part to lower unemployment rates.  This has allowed some manufacturers and service providers to raise prices and rates.  However, this is offset somewhat by long-term low population growth.  U.S. population growth has slowed from 1.8% in the 1950’s to 0.7% currently and is expected to slow to 0.5% over the next two decades.3  Most of the developed world is also seeing a slowing of population growth.  Less consumers automatically translates into less demand and less upward pressure on prices.

Low population growth is itself offset by pressures resulting from low unemployment.  2014 saw a shrinking excess labor force, resulting in labor shortages in regional airlines pilots, drywall installers and truck drivers.  These industries then saw pay increases to attract and retrain workers.  2015 has seen wage increases in the retail sector, with Target, Wal-Mart and Gap all implementing wage increases.  Wal-Mart increased their wages from $7.35 per hour to $9.00 per hour this year and noted plans to further raise them to $10.00 in 2016.3  The move at Wal-Mart will impact 500,000 employees.  As excess labor continues to decline, we’ll see continued upward pressure on both wage and price inflation.

Combine all of these factors with the current low lending rates by the Federal Reserve and it gives us a fairly stable, low inflation rate.  Analysts do expect to see an uptick in inflation and we agree with their overall theses – oil prices will rise at some point, the Fed will raise interest rates at some point, continued wage pressure will increase inflation to some degree.  What is uncertain is the timing and the degree to which inflation will rise.  We do not see any significant changes in the near future, but will continue to watch this area of the economy for the changes we expect.

Summary

The US bull market is starting to feel fairly mature as the market enters its 7th straight year of growth since the low in March 2009.  The historical broad market price-earnings ratio (PE) average is near 15.5, with a fairly wide range for normal activity.  The current broad market PE ratio of 20.65 is a bit high, but only at the high end of that average range.  It does not mean U.S. stocks are seen to be richly valued, but does make the hunt for undervalued stocks poised to grow a bit more difficult than at the same time last year.  This has narrowed the focus of the market as investors tend to look for more well-known stocks with growth potential and little chance of contraction, while avoiding much of the market that is felt to be fairly valued.  We see a shorter list of securities attracting new investment than we did at the same time last year, indicative of a more mature market.

Low interest rates make a shift to fixed income securities more challenging than during similar periods in the past.  There are bright spots for the investor though.  The PE equivalent for international markets is low, resulting in attractive entry points to many international sectors.  For this reason, we share a widely held viewpoint to continue to favor the international markets and add additional investments.  We agree that broad international markets are poised for greater rates of return than broad U.S. stock markets and have increased the international weighting of many accounts this year in order to capture these expected gains.  We are also looking at alternative investments like managed futures.  There are some interesting alternative oriented investments that are managed with an eye towards low levels of risk that are appropriate for some portfolios.  While we still look to U.S. stock exposure as the best way to grow client accounts, we are adding exposure to other sectors in order to properly diversify accounts in the current economic environment.  As always, we will continue to monitor economic developments and adjust client portfolios to take advantage of changes as appropriate for each client.

 

1) http://inflationdata.com/inflation/inflation_rate/long_term_inflation.asp

2)  http://www.bls.gov/news.release/cpi.nr0.htm

3) http://news.morningstar.com/articlenet/article.aspx?id=690965

June 2011

Posted by Koenig Investment on
 June 2, 2011
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News programs, magazines, and other forms of media have to provide an audience to their advertisers if they want to stay in business. This results in many stories with exaggerated emotional content that try to hook viewers. We all know how this works and do our best to read between the lines. That is often difficult with stories of a technical nature that take us out of our comfort zones.

During the recession and recovery I have seen a number of programs or articles take an interesting data point that is worth mulling over and use that to speculate on the end of the U.S. economy as we know it. These same spokespeople and authors then treat the next day’s new data point with the same level of heightened emotion. Part of my job is to help you navigate this ever present media noise.

Commodities

I have recently read and seen some thoughts stating lower commodities prices are worrying as they signal a weakening U.S. economy. It is true that there are a number of speculators within the commodities markets who trade based on their expectations of overall economies in the near future. A pullback of these more speculative positions does not necessarily mean that these speculators see a weakening economy though. We have seen a rise in commodities decoupled from actual demand for the underlying materials. We are now seeing an unwinding of some of the more speculative commodities positions taken in recent months. This does not signal a weakening economy, but rather a return to commodities prices that reflect the actual cost of materials based on real world demand. This return will result in lower prices for some commodities, which will in turn help consumers and their spending power. That will help the general economy, not hurt it.

Higher commodities prices create higher levels of inflation, creating a drag on economies. Lower commodities prices are good for an economy as consumers then have more money for discretionary spending. That is still the bottom line when it comes to commodities and their effect on an economy.

Quantitative Easing

The Federal Reserve is purchasing government debt and increasing the money supply. Money supply growth has kept pace with moderate levels of economic growth and inflation. M2 refers to the total amount of money in circulation outside of bank vaults, savings and checking account balances, money market balances, and similar liquid assets. The May 26th release of the Federal Reserve’s H.6 statistical report1 shows M2 growth of 4.9% over the past year. Even conservative analysts deem this acceptable for an economy whose GDP growth plus inflation are about the same level. Where is the U.S. in terms of GDP + inflation? The Bureau of Economic Analysis’ May report2 notes 2010 4th quarter U.S. GDP at 3.1%, with 2011 1st quarter GDP an estimated 1.8%. The Bureau of Labor Statistics April report is their most recent. They note a year-over-year inflation increase of 3.2%.3 M2 growth is not exceeding the combination of GDP and inflation for the U.S. economy.

A quick look at exchange rates over the past 5 years shows the U.S. above the 5-year average against the Euro and the British Pound.4 We do not have excessive inflation or devaluation of the U.S. Dollar due to quantitative easing. Banks are still not lending at rates high enough to cover reasonable demand. The Federal Reserve’s policy of money supply growth is helping make up for these low lending levels, not fueling runaway inflation or currency devaluation.

Inflation

What will the inflation rate do? Will we see Zimbabwean effects on the U.S. Dollar, or more moderate runaway inflation such as Argentina saw several years ago? There is much fear in many hypothetical scenarios, but not often much in the way of fact. As noted above, inflation has increased to just over 3%. This is about average for the last decade.5 It has risen since 2009. However, this is due in part to a reversal of the deflationary pressure of the recession and the increase of commodities prices noted above. It is worth noting that the rise in inflation is just a rise to average levels.

Inflation increases due to demand based price pressure. The global economy is still too weak to exert much upward inflationary pressure. Nor is Federal Reserve policy causing inflationary pressure. Inflation will be an area to watch when the economy does revert to higher growth levels, but there is still too much drag on both the national and global economies to stimulate high levels of inflation.

Summary

The economic outlook is more of the same. Housing is a weak spot that is not likely to change soon. Unemployment levels are slowly decreasing. Credit is still tight. Companies are still earning profits. The economy is growing, but at a slow pace. It is hard to write an engaging article or retain viewers with headlines of “More of the Same” and “No Change Today”. While the media may have their reasons for speculative narratives surrounding the economy, much of what is said is just noise.

1) http://www.federalreserve.gov/releases/h6/Current/

2) http://www.bea.gov/scb/pdf/2011/05%20May/0511_gdpecon.pdf

3) http://www.bls.gov/news.release/cpi.nr0.htm

4) http://www.oanda.com/currency/historical-rates/

5) http://www.inflationdata.com/inflation/inflation_rate/historicalinflation.aspx

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. The information provided is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a solicitation of the purchase or sale of any securities.

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