This is part of an ongoing series of articles published by Johnson Financial Group. This issue is written by Brian Andrew, EVP, Chief Investment Officer.
No, not the government shutdown—the winter weather kind. Over the weekend, I was stuck in Minneapolis overnight due to a winter storm that shut down the airport. Winter weather has gripped much of the Northeast and more recently, Midwest (too late for the southern duck hunting season—the reason for my trip), and we are sure to hear how weather reduced economic growth during the fourth quarter. While the Midwest winter has taken an extra long time to arrive, winter weather is an annual event made to sound unique each year.
There is too much recession talk, and the winter weather and government shutdown will likely fuel more of it. Keeping an eye on the actual economic data may assist us in maintaining our perspective.
The first look at fourth quarter economic growth is due on January 30, yet might be delayed due to the government shutdown. (The Bureau of Economic Analysis produces the data and is a department of the U.S. Department of Commerce.) Current estimates for the report show a growth rate of 2.7%.
During 2018, second and third quarter annualized economic growth ran above 4%. That's a rate that is double what the economy is likely capable of, so a return to “normal” isn't surprising. The third quarter rate was 3.4%—that's .7% higher than the first quarter 2019 estimate. This anticipated reduction in U.S. economic growth is likely what caused much of the decline in stock prices and the rally in bond prices during the end of last year.
Since the first of the year, the stock market's recovery (the Dow Jones Industrial Average is up over 6%) is more likely due to a slight improvement in investor sentiment. However, as asset prices adjust to the potential for a slower economy, we'll see more bouts of selling pressure. Weaker economic growth data for the fourth quarter of 2018 and first quarter of 2019 will reopen the recession debate and may cause a decline in investor sentiment similar to what we saw late last year (although we're not in agreement with the recession sentiment).
Fiscal policy refers to the decisions made by the Federal government and the effect they have on the economy. This includes how the government collects revenue (i.e., taxes), how it spends money, the level of regulation on commerce and the policies it implements. The 2018 economy benefitted from a reduction in the corporate tax rate, which led to higher corporate capital expenditures, less regulation and better global economic growth. While raising the government's fiscal deficit, investors seem to have looked past that. Still, the positive effect of the lower corporate tax rate is not entirely to be dismissed and will likely result in some residual benefits in 2019 as well.
An effort to reduce the amount of regulation has also had a positive impact on corporate spending.
While certainly negative for the many furloughed Federal employees, the shutdown should have minimal effect on the economy's growth rate during the first quarter (estimated to be less than .1%), although it may wreak havoc on January's employment figures. The announcement over the weekend that the government would reopen, in hopes a deal is reached by February 15, could provide a small lift. However, given the distance between sides over immigration issues, the possibility of revisiting and prolonging the shutdown isn't remote. If it were to drag on, it could then have a more meaningful effect on the economy's already slowing growth rate during the first half of the year.
Trade is also on the docket for the administration, and we have until February 15 to reach some type of a deal with China or the higher tariffs may go into effect. Looks like mid‐February will either be cause for a victory lap on some fronts or potentially add to the market's already tepid sentiment regarding fiscal policy.
The Federal Reserve will likely provide some clarity on its policies this week. The communication debacle during the fourth quarter will have Chairman Powell trying his best to let markets know that it remains data dependent (a little more challenging given the pace at which economic data has been delivered during the shutdown). Because some of the parts may be missing from the Fed's data puzzle, it will likely remain on the sidelines during the first quarter, and we won't see any additional interest rate increases.
Still, markets will continue to react to the tighter financial conditions we'll see resulting from the increase in the Fed Funds rate from 0% in 2015 to the current range of 2.25%‐2.5%. If the Fed does indeed reduce the pace at which rates are increasing, however, we could see a favorable uptick in sentiment in the second half of 2019. This pause in rate increases along with the potential for some improvement in the trade situation could provide a continuing near‐term lift to stocks despite the decline in earnings expectations we'll likely continue to see throughout the first quarter.
There is no doubt that we'll see weaker growth across the globe during 2019. We'll pay attention to real information that provides insight into whether our outlook of a return to “normal” is in the cards or not. Let's hope next year's winter follows a “normal” pattern and the ducks return to Arkansas!
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