Stocks finished mixed for the week as markets digested the strong gains for the month of June. Investors also awaited the much anticipated G20 Summit in Japan with hopes of a trade truce and resumption of negotiations between the U.S. and China. The week marked the end the quarter and the first half of 2019, as well as an important milestone: the 10th anniversary of the current economic expansion. While volatility picked up modestly in the second quarter of the year, both bonds and stocks continued to rise, adding to this year’s gains. The main drivers of performance have been, and will continue to be in our opinion, shifting central bank policies (with officials showing more willingness to step in to sustain the economic expansion), continued trade tensions and concerns around global growth. This economic expansion might now be the longest, but it still has room to run, in our view.
An Oldie but a Goodie
The release of “Toy Story 4” on June 21 brought to a close Disney/Pixar’s longest-running franchise, spanning nearly 24 years since the first movie. Over that time, the storyline evolved along with its quality and characteristics. Last week also brought the end of the quarter, making this current U.S. economic expansion now the longest-running one on record, spanning back to 2009 (surpassing the 1991-2001 cycle).
We know this expansion is old. After all, when it began, nobody had ever taken an Uber, the iPhone 4 didn’t exist, and no one had ever used Instagram to share a picture of his or her dinner (or anything else). We also know the quality and characteristics of the economy have evolved over time. But the question now is, can this expansion get even older, and if so, will it age gracefully? Our short answer to the first part is yes. However, like “Toy Story 4,” we doubt the latest installment of this expansion will look the same as what we’ve seen so far.
- Sibling rivalry – While this current expansion now holds seniority, it doesn’t necessarily hold superiority over its kin. Prior expansions have lasted an average of roughly six years. It’s far from guaranteed, but a reasonable case can be made for this one to make a run at living twice as long. In terms of bragging rights:
- The ’60s expansion holds the crown for the strongest, with the economy booming on the back of consumer spending (fueled by a dramatic rise in consumer credit), tax cuts and government spending (Vietnam, social programs, etc.).
- The expansion of the ’90s is second in terms of length and strength, driven by the advent of the internet age. Productivity rose along with household spending and business investment. Eventually this produced the tech bubble, the collapse of which ended the economic run.
- The expansion through the early/mid-2000s was born from low rates and grew on the back of the booming housing market. This was, unfortunately, also its undoing as the bursting housing bubble sparked a financial crisis that resulted in the steepest economic downturn since the depression.
- The current expansion now sits on top in terms of longevity. Born from the Great Recession, it was a bit wobbly at first but has sustained itself on a diet of supportive central bank policies and steady improvement in the labor market, with unemployment now the best in half a century.
- Its weakness has been its strength – A defining feature of this economic rebound has been its sluggishness. GDP growth has averaged 2.3% since it began, compared with a long-run average closer to 3% and average growth of 4.3% for the other three expansions that made it past their 7th birthday. In fact, while quarterly GDP growth did reach a high of 5.1% in the second quarter of 2014, this is the only expansion on record to not have a calendar year of GDP growth in excess of 3%.
While this sounds more like a eulogy than a commemoration, we think this is a primary contributor to its longevity. Often – and somewhat perversely – the strength of the economy becomes its undoing, as an overheating economy produces rising inflation and/or asset bubbles (inflated by euphoria). The past 10 years of modest growth, while frustrating, have not fostered a surge in inflation or economic/asset imbalances that pose an imminent threat.
For example, in the eight quarters leading up to the end of the expansion in the 1960s, GDP growth averaged 4.2%. The average was 4.9% in 1998-1999 and 3.3% in 1988-1989. Despite some pockets of weakness this year, the U.S. economy has found some footing in recent years, and we do expect growth to persist into 2020. However, we doubt growth in the near term will accelerate to levels that would create the threats that come from a booming economy. The moral around hubris aside, the old fable about the tortoise and the hare is an applicable metaphor.
- Source: Federal Reserve Economic Data, Edward Jones.
- Age spots – Age isn’t a cause of death for the economy, but we don’t think this expansion is as spry as it used to be. GDP growth in the final stage of the cycle is often strong but also more variable as late-cycle risks become more prevalent. In the last four quarters of the long expansions of the ’60s and ’90s, there were two quarters of strong growth averaging 4.8% and two averaging 1.2%, signaling that strong growth can be increasingly sensitive to late-cycle risks. We don’t think a recession is imminent, but existing tailwinds and risks have grown more balanced:
- Good prognosis:
- Labor market – This is the greatest source of energy for the expansion moving forward. Unemployment is historically low, providing a positive outlook for wage growth and thus consumer spending, which constitutes the lion’s share of GDP. Last week, data showed that the personal savings rate stands at 6.1%. This is in line with the long-term average but down from this time last year and the year prior – signaling consumers remain willing to spend. Historically, the savings rate has risen in advance of recessions as consumers grow more cautious of emerging economic risks.
- Corporate profits – Earnings are expected to rise again this year. While growth will likely slow to a low single-digit pace (compared with more than 20% growth last year), expansions don’t tend to end when corporate profits are rising at even a modest pace.
- Interest rates – 10-year rates remain below 2.1%, while the Federal Reserve has recently signaled a more responsive policy approach to sustain the expansion.
- Areas of concern:
- Weakness in manufacturing – Manufacturing activity began to slow toward the end of last year, presumably reflecting both trade uncertainty and weakness in foreign demand due to slowdowns in Europe and China. A broader, deeper decline in overall business investment would be a concern for the expansion.
- Trade tensions – While last week’s G20 meeting signaled both sides are still at the table, we don’t anticipate a more concrete trade deal between the U.S. and China until much later. Rhetoric and tariff threats will likely keep markets on edge in the interim.
- Geopolitical threats – Conflict with Iran, Brexit and next year’s presidential election are just a few of the political uncertainties that represent short-term risks to consumer, business and investor confidence.
- The Fed, not Father Time – Historically, expansions have ended at the hands of a popping bubble (tech, housing), an external shock (oil) or overly restrictive monetary policy. We don’t believe any of those conditions are brewing at the moment, suggesting to us that this sluggish expansion has legs. That said, it won’t last forever, and while smaller risks today can become expansion killers in the future, we think a probable end to this cycle could come as inflation pressures eventually build to the point that the Fed has to resume a more restrictive stance. For investors, the good news is that bull markets rarely end without an accompanying recession (markets typically peak several months before the recession officially begins). This expansion is not on life support, and we think should continue to offer support to the stock market moving forward.
Craig Fehr, CFA
|Dow Jones Industrial Average||26,600||-0.4%||14.0%|
|S&P 500 Index||2,942||-0.3%||17.3%|
|10-yr Treasury Yield||2.01%||-0.05%||-0.68%|
Source: Bloomberg, 06/28/19. *5-day performance ending Friday. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.
The Week Ahead
U.S. financial markets will be closed Thursday for Independence Day. Major economic news includes the ISM manufacturing Purchasing Managers’ Index reported on Monday, auto sales reported on Tuesday and June’s jobs report released on Friday.
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