Economic Perspectives
November 20, 2024 - Mid-Quarter Investment Outlook
The US economy continues to expand at a robust pace. Real GDP could grow an average rate of 3% over the next four quarters, turbocharged by pro-growth fiscal policies. Corporate earnings remain in a strong uptrend, led by the technology sector. The election of Donald Trump will have significant implications for the economy and financial markets over the next several years, including a faster rate of economic growth, much higher inflation, faster profit growth, and higher long-term interest rates.
I expect inflationary pressures to build over the next two years, strongly suggesting that the benign disinflation phase of the past two years is ending. A further easing in monetary policy is not needed but the Federal Reserve will likely cut rates nonetheless. The breakout in bond yields will ultimately infect the equity market, which is already in overvalued territory. Investors should expect an eventual rotation in equity market leadership over the next year, as cyclical stocks and value managers outperform the technology sector.
October 21, 2024 - How this Economic Cycle Differs from the Norm
As the economic expansion enters its fifth year, it is a useful exercise to study the unique drivers of this cycle relative to previous cycles. Whereas most recessions have been countered by the government with a timely fiscal and monetary stimulus response, the amount of stimulus provided in response to the pandemic in 2020 and 2021 was unprecedented. The surge in government-supplied liquidity resulted in a spectacular rise in asset prices, led by global equities, speculative-grade corporate bonds, gold, and crypto currencies. The magnitude of disruptions to the labor force during the past four years of economic recovery has been unprecedented.
The current federal budget cycle is an enormous deviation from norm: The deficit bottomed early in the expansion (2022) at 3.7% of GDP and has moved steadily higher in most recent years, currently at 7.2% of GDP, an all-time record for an economy at full employment. The unique nature of the current economic cycle has enormous investment implications, the most important of which is that the life of the current expansion could be extended for longer than generally perceived by financial markets.
September 30, 2024 - Quarterly Economic Outlook
The US economy remains on a sustained growth path, with real GDP projected to expand at a 2% annual rate in the third quarter. My forecast assumes an acceleration in growth to 2.5% over the next four quarters. The welcome decline in core consumer inflation since 2022 is nearing an end and will reach a cyclical bottom around 2.5% prior to yearend. My forecast assumes accelerating inflation in both 2025 and 2026.
The September FOMC meeting marked an important inflection point in the current economic cycle. The end result will be even faster growth in spending and an extended business expansion well into 2026. The global economy will remain on a sluggish growth path over the next year, but could strengthen later in the year, depending upon central bank policies, geopolitical developments, and private sector confidence.
September 9, 2024 - Why the US Economy Continues to Outperform
The performance of the US economy has distinguished itself in recent years relative to the rest of the world. The American economy is driven overwhelmingly by services and domestic demand, with relatively low exposure to manufacturing and export trade. The US economy has also benefitted enormously from advances in technology whereas most other major economies have failed to keep pace. The US is the world leader in technological innovation and by a wide margin. Both US and world inflation will remain lower than otherwise, especially if China continues its policy of overproduction and dumping of cheap manufactured goods into world markets.
Global bond yields will likely remain lower than otherwise, because of positive inflation trends and expectations for slower growth in world GDP. The US equity market will likely fluctuate within a volatile trading range until bond yields reverse direction and drift higher. A sustained rotation in global equity leadership in favor of non-US markets will occur once the US relative GDP growth advantage begins to fade. The US dollar will remain stronger than otherwise until the wide gap in GDP and profit growth rates favoring the US moves in reverse.
June 24, 2024 - Quarterly Economic Outlook
The future trend in inflation is the single most important variable in the economic and investment outlook. The outlook for inflation is predicated upon the growth rate in aggregate spending and output relative to the underlying potential for noninflationary growth, estimated at 2%. Sustained economic expansion in excess of 2% will exert upward pressure on inflation. I continue to believe that a return to the Fed’s 2% inflation target is extremely unlikely, absent a recession. There is no change in my forecast that core inflation will range between 3% and 3.5% for the remainder of this year and could approach 4% in 2025. My forecast also assumes that real GDP will increase at a 2.5% rate over the next year, only slightly below the average 2.9% growth of the past year.
The probability of an outright recession during the next year is minimal, absent an exogenous shock. The Federal Reserve is eager to cut policy rates but will likely be patient in the context of a healthy economy and labor market. My forecast assumes rate cuts in September and December of this year, lowering the federal funds target from 5.5% to 5%. The economy does not require additional monetary stimulus, in my judgment. The implication is that any further easing in monetary conditions by the FOMC will result in an overheated economy in 2025, with rising inflation and long-term interest rates. A highly expansionary fiscal policy will also support economic growth and raise the risks of inflation and rising long-term interest rates.
May 28, 2024 - Will US Households Continue to Spend?
Investor concerns regarding the health of the consumer sector are becoming more widespread. However, my research leads to a more favorable conclusion, with a forecast of sustained growth in spending throughout this year. The most important variables in the outlook for private consumption are employment and wage and salary income, adjusted for inflation. Hiring remains healthy, and household income is increasing at a pace well in excess of the inflation rate.
Household balance sheets are extremely liquid and net worth has increased by more than 40% since 2020. Consumer credit remains unusually healthy considering the maturity of the expansion cycle and the steep rise in borrowing costs. Delinquencies and defaults are in a rising trend, but in most cases are still below pre-pandemic levels. A breakout in bond yields as expected later this year poses a serious threat to an equity market already in overvalued territory.
May 20, 2024 - Monetary Policy, Inflation, and US Credit Markets
Although Fed officials began 2024 optimistic that they would be able to lower rates, several factors have kept the Fed at a cautious stance. With current conditions supportive of sustained economic growth, business owners are increasingly faced with the question: where is the market headed?
Especially in times of increasing financial market uncertainty, it’s important for borrowers to establish capital relationships ahead of needs in order to keep options open.
April 8, 2024 - When Will the Fed Begin to Cut Rates?
Fed Chairman Powell is eager to cut policy rates but has been deterred by recent hot economic data on spending and inflation. My forecast assumes that the Federal Reserve will implement one or two rate cuts this year. The primary risk in the investment outlook is that the Fed will decide on a more aggressive easing path, which would culminate in an overheated economy.
Contrary to the official view of the FOMC, current policy settings are not restrictive. Financial assets are overvalued and vulnerable to a correction when rising inflation compels the Fed to tighten monetary conditions. Perceptions of a more hawkish monetary policy would trigger a rise in market yields, forcing bond prices lower. Because of the very strong correlation between the stock and bond markets, rising bond yields would result in falling stock prices.
March 25, 2024 - Quarterly Economic Outlook 1Q24
The US economy remains on a sustained growth path, with inflation-adjusted GDP increasing at an estimated annual rate of 2.5% in the first quarter, well above the economy’s long-term growth potential, estimated at 2%. US GDP is benefitting from ongoing strength in private consumption, nonresidential fixed investment, and government spending. I continue to believe that the probability of a recession during the next year is low because the traditional catalysts for an economic downturn are not yet in place.
My 2024 forecast assumes real GDP growth of 2.5% and an average core consumer inflation rate of 3.5%. Company earnings growth should average close to 10%, while the unemployment rate should remain below 4%. The downside to this otherwise healthy economic backdrop is the potential for sustained upward pressure on inflation, implying a more hawkish Federal Reserve and a high likelihood of another upleg in long-term interest rates.
February 27, 2024 - Is the Disinflation Trend Nearing An End?
A bottoming process in the disinflation trend of the past 18 months appears to be underway. The current run rate for inflation is best measured using three-month moving averages. Core inflation is currently 4.0%, up from 3.2% in the previous three months and a cyclical trough of 2.6% during the third quarter of last year. The underlying driver of future inflation is vigorous aggregate demand in a tight labor market, with most industries operating at full capacity. A dearth of economic slack is the primary enabler for workers to achieve negotiating power and for businesses to exercise pricing power.
A combination of healthy economic growth and a rising trend in inflation will compel the Federal Reserve to maintain a tighter monetary policy than generally expected. The FOMC will cut rates no more than twice this year, far less than anticipated. The implication is that investors should be prepared for another upleg in government bond yields as the year unfolds. Because of the tight correlation between bond and stock returns, a sustained rise in bond yields could trigger an equity market selloff at any time.
February 5, 2024 - A Major Inflection Point: The Long-Term Economic Consequences of the Pandemic
The Covid-19 pandemic that began in early 2020 marked a crucial inflection point for the global economy and was arguably one of the most significant economic shocks of the past 100 years. Perhaps the most significant repercussion of the pandemic is an enlarged presence and role of the federal government. Exceptionally large budget deficits are likely to persist in future years, with broad economic, financial, and investment implications.
Compared with an average annual rate of 2% since 2000, consumer inflation is likely to average close to 3.3% over the next five years. Investors should expect the Federal Reserve to embrace a more restrictive monetary policy when compared to recent decades, implying a flatter yield curve.
December 27, 2023 - 2024 Economic Outlook
Two thousand twenty four should be a year of sustained economic growth, albeit at a more moderate pace than in 2023, accompanied by solid gains in both employment and company earnings. The downtrend in inflation will persist during the first half of the year but will reverse course later in the year. The FOMC tightening cycle has ended and rate cuts are likely during 2024, but to a much more modest degree than discounted in the futures market. Private sector borrowing costs will rise during the year and credit losses will remain on an upward trajectory. Recession has been postponed but not canceled, and economic risks will increase as the year unfolds, consistent with the current mature phase of the expansion cycle.
November 14, 2023 - The Outlook for Long-Term Interest Rates
Market yields on the benchmark ten-year US Treasury bond have surged from a low of 3.25% earlier this year to 4.6%, down from a peak of 5%. The current 4.6% market yield is comprised of a real yield of 2.2% and an inflation premium of 2.4%. Nearly 90% of the increase in yields can be attributed to the spike in real yields. Assuming a normal real yield of 2% and an inflation premium of 3%, fair value for ten-year US Treasury bond yields would be 5%.
From a short-term cyclical perspective, bond yields are likely to remain in an interim consolidation phase uptrend, followed by further increases in 2024. Rates will not peak until there is concrete evidence that aggregate spending is peaking. For borrowers, the key takeaway is that market interest rates will remain higher for longer.
October 23, 2023 - Long-Term Investment Returns
An analysis of fundamental trends suggests that the next five years will be very different from that of the previous five, characterized by higher inflation and interest rates. My forecast assumes that the inflation rate will average 3.5% over the five years ending in 2028, with an average yield of 5% on benchmark ten-year US Treasury bonds. Global equities should outperform global bonds, with leadership likely to be found in international markets. Small-capitalization stocks and value stock managers should also outperform the S&P 500, which is intrinsically a large-cap growth index. Following a period of cumulative losses since 2018, a diversified portfolio of investment-grade bonds should generate positive total returns, although only slightly above the 3.5% inflation rate.
September 22, 2023 - Special Report: The Fed Acknowledges Economic Reality
As widely anticipated, the Federal Reserve held policy rates steady at its FOMC meeting yesterday, with the federal funds target remaining in a range of 5.25% to 5.5%. At the same time, the Fed delivered a hawkish message with respect to economic growth and the future path of policy rate.
September 18, 2023 - Quarterly Economic Outlook 4Q23
There are no changes to the broad contour of my economic forecast. Real GDP should expand at a 2% annual rate over the next four quarters, accompanied by a 5-8% increase in company earnings through the middle of 2024. Currently at 4.5%, core consumer inflation will continue to decline but will encounter resistance early next year around 3.5%. Credit quality has deteriorated — consistent with business cycle theory — but not yet at an alarming pace. Federal Reserve policy is on hold for the foreseeable future, but policy rates are likely to remain higher for longer than currently discounted in the bond market.
August 28, 2023 - Crosscurrents in the Outlook for Inflation
The trend in core inflation will continue on a downward path over the next six months, but at a slower pace than generally expected. A further meaningful decline in inflation from current levels will be difficult to achieve over the next year in an environment of solid economic growth, business pricing power, and the tightest labor market in 50 years. The Fed will be compelled to maintain policy rates at current levels, thereby disappointing bond bulls. The path of least resistance for Treasury bond yields is upward.
August 15, 2023 - Mid-Quarter Investment Review
Underlying economic and policy conditions remain supportive of sustained growth in spending and output at least through the middle of next year. The inflation rate could drift higher in 2024 in an environment of continued strong economic momentum and the tightest labor market in 50 years. The fixed-income market is vulnerable in an environment of strong economic growth, sticky service sector inflation, full employment, and continued monetary restraint. Bond valuations are also an obstacle to rising bond prices. Underlying fundamentals strongly suggest that equity investors should exercise caution.
August 7, 2023 - An Unconventional Balance Sheet Expansion
Solid growth in consumer spending has been the cornerstone of the US economic expansion over the past three years. The likelihood of recession is extremely low in an environment of robust spending growth. Continued solid economic momentum will exert upward pressure on both inflation and long-term interest rates and prevent the Federal Reserve from lowering policy rates as currently discounted in the bond market. Equity valuations are stretched, as measured by P/E ratios and by the equity risk premium (ERP).
July 27, 2023 - An Unconventional Balance Sheet Expansion
The vast majority of economists have been mistakenly predicting a recession over the past 18 months. The obvious explanation is that traditional indicators of the business cycle have been of little value in tracking this unprecedented expansion cycle. The basic conclusion of this report is that the exceptional strength of private sector balance sheets has more than offset headwinds associated with the severe tightening in monetary conditions. The three critical implications of sustained economic growth are stubbornly high inflation, better-than-expected corporate profitability, and a prolonged period of elevated policy rates.
July 17, 2023 - An Unfolding Manufacturing Renaissance
The US manufacturing sector is on the cusp of a major transformation that could unfold over many years, a culmination of powerful structural forces unfolding within both the public and private sectors. A manufacturing boom will augment GDP growth, enhance productivity, and exert upward pressure on inflation and interest rates. Equity market leadership would shift from the consumer and technology sectors to the industrials and capital goods sectors.
July 5, 2023 - Quarterly Investment Outlook
The central theme in the investment outlook resolves around the traditional business cycle, which is currently in the final phase of expansion that began in mid-2020. Economic and financial conditions will deteriorate as the expansion cycle draws to a close, thereby sowing the seeds for a recession later next year. The outlook for world financial markets will be determined primarily by monetary policy and the future path of inflation. Further meaningful gains in stock prices seem implausible in the face of tightening financial conditions. A combination of elevated inflation and continued monetary tightening will trigger a breakout in yields later this year, accompanied by a contraction in equity valuations.
June 27, 2023 - Quarterly Economic Outlook
There are no changes in the broad parameters of my forecast: Continued economic growth for the remainder of this year with only modest progress against inflation, excluding energy prices. The current expansion cycle has entered its final phase, which means that investors should expect a progressive increase in classic cyclical pressures over the next six to nine months. The odds of recession will increase during 2024. History shows that long-term financial assets perform poorly in the final stage of an economic expansion cycle.
