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Wednesday, August 1, 2018

No need to rehash the Q2 GDP report, which was pretty good especially as nominal GDP grew by a strong 7.1%, up from 4.2% in Q1. First, if there were a binge in pre-tariff inventory buying it has not occurred yet; they dropped by the biggest amount since 2009. Investment growth (+9% H1) implies that the incentives from the tax bill may be acting on the economy. And the most interesting kernel in the report was the five-year benchmark revisions, which hiked 2017 personal savings rate to 6.7% with Q2 at 6.8%, putting a pall over the narrative that consumers are maxed out.

This is a great history but what can we expect going forward? 1) In the July employment report, watch average hourly earnings, which are basically zero in real terms. It will be tough for the Fed to become more aggressive without more inflation confirmation from the core level. 2) It is clear there will be an inventory-build in H2 and I expect to see the H2 GDP consensus move above 3%. 3) The key to the longer-term outlook is productivity, with increased Labor Force Participation Rate (LFPR) to a lesser extent. The consensus expectation for Q2 is a 2.3% increase (SAAR), which would deliver a four-quarter rise of 1.4%. That is not a breakout by any means, but since 2010, productivity has averaged just 0.7% growth, so at least it's a start. That data comes out on 8/15. - Special Guest Blogger: Tim Kearney, PhD

Tuesday, July 31, 2018

Today’s Federal Reserve’s Open Market Committee (FOMC) is expected to end tomorrow benign with no rate increase. Despite the dog days of summer solid economic data is rolling in with July’s Consumer Confidence (US Conference Board) at 127.4 a near an 18-year high; June’s PCE Core inflation y/y at a tame 1.9%; Chicago Manufacturing PMI rose to 65.5 a six month high in July; and Q2 GDP at booming 4.1%. Meanwhile Q2 S&P 500 corporate earnings growth and revenue, with half the companies reporting, are at 21.4% and 8.3% respectively. Solid growth with inflation back to trend is as close to Goldilocks as you get and does not raise concerns for the FOMC. Please see our 2018 Mid-Year Outlook: Confident Economy, Cautious Markets for further insight into our view.

Friday, July 27, 2018

GDP in Q2 hit its highest level in four years, expanding 4.1%. The increase was due to both a snap back in consumer spending hitting a robust 4% and to a continued strength in business investment (CAPEX) climbing 7.3%. The tax cuts will take time to work through the economy, but the rise in business investment is indicative of the foundation needed for long-term higher growth and increasing productivity. As a bonus, first quarter GDP was revised up to 2.2% from 2.0%. Indeed, there are many investors that are wholly surprised by this stunning report that we referred to as a “stealth economic boom” and aptly take a victory lap on our call for Q2 GDP to have a “4-handle” in our Voya Global Perspectives Mid-Year Outlook.

Thursday, July 26, 2018

The tone on trade shifted yesterday with President Trump’s meeting with the EU. Both sides agreed to hold off on further tariffs. The EU is a U.S. ally and working together should be a given. Some of the tariffs in place may not necessarily be fair, but there is no allegation of unfair trade practices. In addition, trade talks with North American allies have also stepped up. The trade headache is far from over but it is good news when allies are working together and can potentially create a united front to combat the unfair trade practices they all experience with China. This pause comes just as some companies are beginning to dial back forecasts on earnings because of higher prices resulting from the recently enacted tariffs on steel and aluminum, which raised prices even on domestic sources. Meanwhile the market is grinding higher on the continued stellar earnings growth but is still keeping a wary eye on the Fed, the dollar and further possible trade tensions. Please review the Global Perspectives Mid-Year Outlook: Confident Economy, Cautious Markets.

Wednesday, July 25, 2018

Dollar strength seems to be relentless and that is bad for emerging markets and currencies. While there is a rates advantage between the U.S. and Europe/Japan, that doesn’t work for emerging market currencies. Over the past three months, the best performing currency, surprisingly, has been the Mexican peso. The peso is off by less than 1% versus 2.4% for the yen and 4.4% for the Euro. Enter the tariff wars, which in a sense are proxy wars for trade (and other) difficulties. The International Monetary Fund (IMF) projects that following through on current trade threats could drop global growth “by 0.5% percent below current projections by 2020”. The IMF actually believes that while the U.S. does face trade discrimination it has a lot to lose in a trade war; go figure. As we head into this round of difficulties, a weaker Chinese Yuan appears to be both the right response to the trade threat but the absolutely wrong step in terms of a trade war. The reason is that China has lurked for a long, long time as a potential currency manipulator. There are various assumptions on both the direct impact of U.S. tariffs on China (seems to run around 0.3%) and the secondary impact on confidence, investment, capital flows etc. – and that is unknowable. Nevertheless, it is difficult to see, with the threat of being labelled a currency manipulator, that the PBoC is not only content with a weaker exchange rate but is seeing it as a strategy. Big mistake. For more on emerging market currencies, please see page 55 of the Global Perspectives Book. - Special Guest Blogger: Tim Kearney, PhD

Tuesday, July 24, 2018

Earnings are stealing the show, coming in even better than expected. But, investor reaction has been somewhat muted. Investors should always remember their ABC’s: A=Accelerating Corporate Earnings, B=Broadening Manufacturing, C=Consumers, the economic Game-Changer. The ABC’s are forging ahead but the negative news gets more clicks – a stronger dollar threatening earnings, trade tariffs throwing a monkey wrench into manufacturing, higher gas prices and interest rates impeding consumer spending. The short-term headline risks are easier to see than the long-term underlying green shoots of true economic growth. But, the U.S. economy is growing at the fastest pace in a decade. Pay close attention to investment spending when the Q2 preliminary GDP report is released on Friday. It is crucial that companies up their CAPEX spending now to enhance productivity and promote future growth above the sickly 2% trend. An exceptional GDP report will be downplayed as a one-off tax cut boost. A disappointing GDP report will be touted as an “aha, I told you so” opportunity. Don’t succumb to short termism. Look for the underlying trends. See Karyn Cavanaugh’s comments on the market.

Friday, July 20, 2018
Wide variations in sector returns have generally been the norm; this year information technology and healthcare are the leaders; energy and telecommunications are the laggards.

Economics and politics are not only dating, they are engaged. In the past week, the economic data has been fantastic, yet somewhat boring. In contrast, investors have confronted a myriad of concerns regarding tariff threats, NATO ally spats, Russian frenemy meetings and a president that freely opines on the dollar strength and the Fed’s interest rate policy. Understandably, investor caution has heightened. However, one thing is solid and certain and that is company earnings. Less than 20% of the companies have reported for Q2 but the earnings beats are far surpassing the misses. Earnings growth projections are now up to 22% (Reuters) and revenues are expected to rise by more than 8%. Even the sector earnings laggards (Utilities and Real Estate) are looking at firmly positive growth. More importantly, company forward guidance has been affirming a very strong economic backdrop and earnings trajectory. Instead of being drawn into the relationship theater of economics vs. politics, investors should focus on the stable relationship between company profits and the market. There is plenty of drama to go around on Bravo TV. As always, fundamentals drive markets. The market is poised for another positive week (and Financials are notably rising from the dead) despite all of the drama, speculation and inflammatory rhetoric on the political stage.
Please follow S&P 500 sector performance on page 18 of the Global Perspectives Book.

Thursday, July 19, 2018
Investors seeking income may benefit from the rich opportunities for higher yield available from global bonds.

The economy is pumping iron, inflation has moved up and the Fed is about to begin unwinding its massive balance sheet, flooding the market with additional supplies of U.S. government bonds. Higher growth, inflation and supply should lower the prices of bonds and thereby increase yields. So why are long-term yields staying so low? Interest rates are reflective of growth and inflation expectations but are also influenced by perceptions of risk and investor demand. On the growth front, U.S. growth has been stealthily accelerating but investors are reluctant to acknowledge it. The Q2 GDP report due out next week may provide a much need wake up call. Meanwhile U.S. jobless claims last week dipped last week 207K, the lowest level since 1969 and industrial production rebounded in June, up .6% with capacity utilization rising to 78%, a multi-year high. As for inflation, it is now at the Fed’s target and not likely to go much higher. Investors may be worried about the inflationary impact of tariffs, which can drive consumer prices higher. However, the devaluation of the Chinese Yuan, down 5.5% in the last month, is deflationary for the world economy and investors experienced that first hand in 2015/2016. It wasn’t pretty. In addition yields are still ultra-low to slightly negative in other parts of the world, driving demand and prices for U.S. bonds higher and keeping a lid on yields. The current 10-year yield on German government bonds is a mere 33bps. And if the Fed continues to raise short term rates inverting the yield curve, investors fear that a recession is imminent despite the plethora of good economic data and no recession on the horizon. Given all this push and pull, it appears that bonds have received the memo; they are just reading it very carefully. Please see global yields on page 33 of the Global Perspectives Book.

Wednesday, July 18, 2018

Mid-point in the year and the U.S. continues to look strong and rocking better than the rest of the world. The consensus for Q2 (published 7/27) is 4%, up from the 2% recorded in Q1. GDP has not printed 4% since mid-2014, and that was following a -1% Q1. The Bloomberg consensus for 2018 as a whole is 2.9%. The National Association of Business Economists (NABE) has an interesting, but I believe a mainstream, look at the economy. While the economy has solid momentum they do not believe that the economy has yet to feel the effects from tax cuts which they forecast will add +0.3% in 2018 and +0.4% in 2019 followed by a 2020 recession. Why? Many forecasters believe that the economic ventilation since January 2017 will deliver just a step rise in the level of GDP before returning to the prior “New Normal” sub-2% trend growth. To be fair, it is a theoretically sound viewpoint – it is tough to call a new trend until there is some evidence of a new trend.

Still, I believe that the generic view underestimates the impact of an investment rebound and there are nascent signs one is developing. Productivity growth is back above 1%; a modest improvement but as the aphorism notes a 1,000 mile journey starts with a couple of steps. The Bloomberg Consensus sees private investment having risen by 7.5% QoQ in Q2, after the strong 7.5% of Q1. It was the outright fall in the capital stock from Q3 2015 to end-2016, which is the key culprit in the U.S. economic malaise. To wit: even slow labor force growth needs a rising capital base. ISM New Orders remain well above 60 and are further good signs for 2018 investment. - Special Guest Blogger: Tim Kearney, PhD

Tuesday, July 17, 2018

Well I’ll be darned, Fed Chair Powell stated with clarity that wages and productivity and not inflation are linked. This is big news in Washington apparently whereas in the hinterland of capitalism we might be inclined to accuse him of being Captain Obvious. When a government punishes capital formation through excessive taxation, you get less of it. Lo and behold, on the promise of cutting business taxes, capital expenditure (CAPEX) surged in 2017 and is gathering steam in 2018. Yes, less taxes more capital formation. Since the pro-business tax cuts we have seen a boom in trade (imports + exports), CAPEX growing at double digits, and today’s industrial production bounce for June at 0.6% topping off a 6.0% quarter is leading to a second quarter GDP growth we expect to have a 4-handle. Yes, four percent GDP growth, that seemed to come out of nowhere, let’s call it a “stealth economic boom.” The bottom-line is, more capital formation equals more tools for workers, which increases productivity and raises real wages. Please read Voya Global Perspectives Mid-Year Outlook describing in more detail the “stealth economic boom” and how it can raise wages without raising inflation.

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