Tuesday, 22 of January of 2019

Economics. Explained.  

S&P 500 Stock Prices

December 13 2018

The S&P has fallen 9.5% after reaching a peak of 2,929 in mid-September.   The market appears to be concerned about a variety of factors.  The expansion is approaching its tenth anniversary which is geriatric, so some fear that the end of the expansion must be close.  It sees growth weakening overseas, particularly in China which is the world’s second largest economy.  It fears a trade war.  And it has seen the housing market fall steadily for most of the year.   The stock market is a leading economic indicator and when the economy is actually beginning to weaken the stock market will be one of the first places that slowdown becomes evident.  But, as they say, the stock market has predicted 10 of the past 3 recessions.  More often than not stock market gyrations are meaningless.  So which is it this time?  Our bet is that we are experiencing stock market noise.  The economic fundamentals in our view remain solid.

With respect to the Fed it is raising rates not to slow down the pace of economic activity but simply to get the funds rate back to a :neutral” level at which it is neither stimulating the economy nor trying to slow its down.  Currently the funds rate is 2.2%.  For years the Fed has believed that a neutral rate was about 3.0%.  Recent speeches by Fed officials suggest that it is rethinking the neutral rate and perhaps lowering it to 2.75%.  We should know more when it meets in mid-December.  Even if it eventually raises the funds rate to the 3.0% mark, the U.S. economy has never gone into recession unless the funds rate was 5.0% or higher.  It is not even close.  As a result, we suggest that the expansion will not end until 2021 at the earliest.

Trump initiated a trade war in February of this year by imposing tariffs on aluminum and steel.  Other countries retaliated.  Trump up-ed the ante by broadening the list of goods subject to tariffs.  A trade war was underway.  As investors around the globe tried to figure out which country might be in the best position to withstand a trade war, they concluded that country would be the U.S. primarily because trade is only 10% of our economy versus 50% or so elsewhere.  Investors flooded into the U.S. stock and bond markets.  The dollar has risen 9% since January.

The rising dollar has crushed emerging economies.  They purchase raw materials for their manufacturing sector.  But those commodities are all traded in dollars.  Hence, a rising dollar implies that their cost of goods sold has risen and they are less able to compete in the global market place.  As a result, their currencies have fallen.  Their stock markets have fallen 20-25% since January and slower growth does lie ahead.  In the case of China, the IMF expects 6.5% growth this year which would be the slowest growth rate since 1990 with even slower growth ahead in 2019 and 2020.  As growth in all emerging and developing countries has slowed, their leaders have sought trade deals with the U.S. to alleviate the pain.  So far deals have been negotiated with Mexico and Canada.  Europe seems close.  China is still a holdout, but if Trump applies tariffs to additional products and raises existing tariffs at the end of this year, our guess is that the pain will be so great that by spring the U.S. and China will reach some sort of accord.  Both will claim victory.  And the global outlook will not look so gloomy.

In any event, the tariffs imposed on U.S. goods should reduce GDP growth in the U.S. by just 0.2% in 2019.  Not exactly something the stock market should be too alarmed about.

Further, we believe the tax cuts and deregulation will boost investment spending for years to come.  That will in turn translate into faster growth in productivity. And that will raise our economic speed limit from 1.8% or so a couple of years ago to 2.8% by the end of the decade.

Finally, the housing market has slowed steadily throughout the year.  But the National Association of Realtors suggests that there is only a 4.3 month supply of homes available for sale.  Demand and supply are in balance when there is a 6.0 month supply of homes available.  If more homeowners put their houses up for sales existing home sales would be 5.8-6.0 million rather than the current 5.2 million.  The problem with housing is a supply constraint rather than a dropoff in demand.

We are well aware of the concerns being voiced by the stock market, but our conclusion is that it is nothing more than the usual stock market noise.

Stephen Slifer


Charleston, SC

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