Economic and Stock Market Commentary for the week of August 31, 2017

The nation’s economy continues to amble forward, performing in much the same unimposing fashion that it has since the recovery began more than eight years ago. On point, after an uneven 2016, in which the growth of gross domestic product took a step back (hurt, in part, by seasonal weakness early in the year), things got underway in much the same frustrating manner in the current 12 months, as GDP growth stumbled in the first quarter, rising by an anemic 1.2%. Things then heated up with the arrival of spring, on the strength of gains in consumer spending, business fixed investment, federal government outlays, and exports. Meantime, inventory changes had little impact in the latest quarter, after drawdowns had subtracted markedly from opening-period growth. In all, GDP gained a solid 2.6% in the April-to-June span.

Now, the challenge will be to sustain this step-up in activity. And that should occur, at least over the near-to-intermediate term. Our cautious optimism reflects a prospective modest rebuilding of inventories in the current half, an expected positive swing in residential investment (following an easing in building activity in both the second quarter and July), and likely gains in business capital investment, exports, and consumer spending, with retail sales already picking up nicely to start the current period. Recent upbeat job growth, rising real estate values, and a mostly higher stock market also should provide the confident backdrop needed to sustain GDP growth of 2.7%-3.0% over the final six months of this year. Thereafter, with the Federal Reserve likely staying the course, and with a possible modest lift from Administration-backed tax reform and infrastructure spending initiatives—which still could be months away, if even then—growth might move further up towards 3%, on average, in 2018. Looking further out, we sense that GDP growth will slow as we conclude this decade and look out to the next 10-year span, based on our view that demand will gradually become sufficiently satisfied to cause at least some softening in selective markets.

Importantly, the case for sustainability is still a relatively strong one. To be sure, this shouldn’t suggest that growth will stay in a tight range throughout our extended projection period. Weather-related issues (particularly early in some years), periodic headwinds on the geopolitical stage (as we are seeing with the nuclear threats out of North Korea and the latest buildup in Afghanistan), the possibility of a trade war with China, and lingering trade issues in North America (centering on NAFTA), possible miscalculations by the Federal Reserve (as it unwinds multi-year monetary easing efforts), or the inability of a politically charged Washington to enact fiscally popular initiatives, such as tax cuts and infrastructure programs, hold the potential to undercut this largely benign outlook. In sum, things rarely go according to design for any length of time. Still, absent such unwanted events, or a sudden bear market, longer-term prospects for the economy seem good, aided by a likely absence of excesses on either the growth or the inflation fronts and the further support of a carefully scripted monetary approach. For now, we see nothing worse than slowing economic growth—including, perhaps, a pause or two—over the next 3 to 5 years.

The Stock Market: The jump-start given to the equity markets following the election last fall of Donald Trump, with that event’s consequent promise of a more business-friendly set of economic policies, remains largely in place as we close in on a year of that vote to shift course. True, things have turned somewhat choppy this summer, as escalating threats on the global front, the mid-August terrorist attacks in Barcelona, increasing political discord within the Trump Administration (and concerns of an ever-greater reach of investigations), and the frayed relations between Congress and the White House, which have all but halted progress on the legislative front, have dampened market sentiment to a small degree. Still, there remains evidence of the sustainability of the bull market—such headwinds notwithstanding—as the Dow Jones Industrial Average, the S&P 500 Index, and the NASDAQ are all higher in the three months since our last Quarterly Economic Review, although the gains have moderated in recent weeks. As such, valuations, already extended at the start of President Trump’s term, have increased further during his brief tenure. Our sense going forward is that with the economy on seemingly secure footing, with the Federal Reserve Board in no apparent hurry to meaningfully tighten the monetary screws, and with the potential payoff from the long-advertised business-friendly fiscal policy changes, additional gains in the market, albeit not easily attained, still appear quite possible.

Conclusion: Three months ago, we observed that stocks seemed priced for near perfection. Clearly, the brief passage of time since then has not altered this view much. That said, we also believe that the case for the bull market’s continuation is still a strong one.

Source: Valueline.com