Past: Where we have been in the economy
Hello, everyone. My name is Michael Conway, CEO of the Conway Wealth Group at Summit Financial Resources. Our objective today is to have what we call a mid-year report or discussion as to where we are half way through the year. We want to evaluate where in the economy we’ve been, where we are, and where we may be going. We’ve created a series of three short videos to take a look at the recent past, present, and future of the economy. We hope you will find them informative and insightful.
Let’s begin our video series with where we’ve been and take a look at the first half of the year. We will review financial markets performance, the economic recovery, consumer confidence, wages and jobs, housing, the Federal Reserves role, inflation and interest rates.
The SNP 500, which is domestic equities, was up 12.6% for the first six months of the year. The MSCI, which is international equities, was actually flat. The Barclays US Aggregate Bond Index actually lost 2.4% as bonds gave ground due to rising interest rates in May and June. Commodities lost over 10%.
As mentioned, the main headline of the first half of this year are the large gains in the domestic stock market. New all-time highs were set in both the SNP 500 and the Dow Jones Industrial Average. In light of new highs, many are asking about the sustainability of the rally. Consideration must be given to the fuel behind the domestic stock market this year. Part of the upsurge was driven by the relief of avoiding some crisis that were brewing last year.
Furthermore, aggressive and unprecedented monetary policy has been very supportive to domestic stocks. Recent news suggests that days of an aggressive Federal Reserve may be numbered. In 2012, politics dominated the investment landscape. Investors were distracted by an election year followed by a new catastrophe that was the fiscal cliff. Now that those fears have dissipated, the markets have rallied. Of course, the resolution to the fiscal cliff and sequestration cuts that followed have combined to create fiscal drag of nearly 2% on economic growth.
Indeed, the US economy faces quite a paradox. Expansionary monetary policy held in check by restrictive fiscal policy. Despite higher taxes this year for nearly every working American, and mediocre new job number, the US consumer has been incredibly resilient. US retail sales have climbed to all-time highs and consumer confidence is the highest it’s been in over five years. Even those fortunate to have jobs haven’t seen much of an increase in their pay check these last four years. Aside from a brief two-month period wage growth has remained below 2% since 2009.
Despite fewer jobs and low wage growth, Americans have been diligently paying down debt. In fact, the total US consumer debt is 1.37 trillion below its 2008 peak and household balance sheets are in much better shape. Net worth is at a new all-time high, consumer debt relative the GDP is at the lowest level since ’03, and delinquencies are at multi-decade low.
Not as many people as we would like are finding work. In fact, only 33% of the population is currently participating in the private sector force as seen in the green box. Another approximately 10% work for the government but even when the government workers are included, more than half of our population isn’t working. A whopping 90 million people could be working but have simply given up even searching for a job. This is vital to understand when hearing that the unemployment rate has declined.
One of the largest negative contributors to the last recession was the housing market and now a significant contributor to the recovery has also been housing. Home prices are rising at a double-digit pace and new homes are being built at a brisk pace. Things have got a lot more interesting recently after Ben Bernanke surprised many by suggesting the Federal Reserve is getting closer to slowing or as we call tapering their asset purchase program. The Fed raise their economic growth forecast for 2014 and believe major risks to the economy have declined considerably. If the economy is getting better, that would be good news for corporate sales and earnings, and stocks could continue to perform well.
Of course, higher interest rates from tighter monetary policy could also be detrimental to the economy. Consumer and corporate spending might slow and mortgage rates have already jumped significantly. The housing improvement we have seen may be heard as a result. The future actions of Bernanke and company will be based on how the economy actually progresses over time. If the economy does not get better or if inflation stays abnormally low, the Fed will likely continue to use quantitative easing to help support economic growth and asset prices.
One of the fears that accompany the Fed’s QE program is the potential for higher inflation. Well, we haven’t seen much of that at all. In fact, two gauges of inflation, the PCE and the CPI have both consistently shown consumer prices rising less than 2%. In one sense then it could be argued that the QE program did exactly what it was supposed to do and didn’t create the inflation that many people feared. Reality is not so simple and price pressures in the future may not be so benign. Pockets of the economy are still operating with significant slack. The labor market is one notable example.
Following the shift in the Fed’s message on the economy, interest rates move higher quickly. The yield on the 10 year US treasury leaped from 1.6% at the beginning of May all the way to 2.6 in June and even higher in July. Of course, bond prices move inversely to interest rates and most bond investors suffer losses. Despite losses in some asset classes and normalization of a historically low interest rates is much needed. It would allow for more attractive returns to fixed income investors and more importantly, represents an improving economy.
This concludes our first video. In episode two, we’ll examine the current state of the economy.