‘Uncertainty’ was watchword during the first half of 2019
“Uncertainty” seemed to be the watchword during the first half of 2019. For example, first quarter U.S. real GDP growth was a better than expected 3.1 percent, while second quarter estimates have been falling, with many economists expecting annualized real GDP growth of less than 2 percent. The ongoing “trade war” with China, though its nationwide impact has been scant so far, is having a large negative impact on economists’ growth estimates – and unfortunately there appears to be no assurance that trade negotiations will be resolved soon, and to economists’ satisfaction.
The longer the tariffs and trade rhetoric persist, the greater their ultimate effects on corporate profits. What began as limited tariffs mostly impacting farm products and importers of steel and automobiles is showing signs of spreading to other more vital industries, such as consumer products and technology. Compounding the issue is that the U.S. dollar has risen almost 4 percent in recent months on a trade-weighted basis, as analysts handicap that foreign economies will suffer more than the United States in a protracted trade dispute. A rising dollar undercuts the value of U.S. companies’ overseas sales and profits. As a result, many Wall Street analysts have cut their S&P 500 corporate earnings growth estimates for 2019 from 8-9 percent to 2-5 percent.
On a more positive note, U.S. unemployment sits at a 50-year low, and the U.S. core inflation rate was a mere 1 percent in the first half of the year. However, housing data was more varied. While year-over-year new home sales rose 6 percent over the first four months of 2019, existing home sales fell 5 percent over the same period. On the other hand, both figures may get a solid boost from the recent plunge in mortgage rates, with the 30-year fixed rate recently falling well below 4 percent, from approximately 5 percent last November.
Certainly, the slide in interest rates this year was unanticipated. At the beginning of the year, it was expected the Federal Reserve Board would, at a minimum, keep the Fed Funds rate the same, or continue to gradually increase rates as it has done since December 2015. Now, bond market investors anticipate the next move by the Fed will be to reduce rates given the growing amount of data signaling the economy is slowing. Moreover, the bond futures market is forecasting three or four 0.25 percent rate cuts over the course of the next 18 months.
Interestingly, while stocks have experienced volatility over the last few months, several of the major U.S. equity indices generated double-digit returns in the first six months of the year. However, for the equity market to move higher in the second half of the year, the Federal Reserve may need to start lowering interest rates again, and relatively soon. Since the beginning of the year, earnings growth projections have declined and stock prices have risen, so valuation metrics have become less attractive. In addition, political tensions with Iran, North Korea and China remain concerning enough to investors to impact stock prices. Therefore, if interest rates are not reduced, it is possible the economy will slow even more than expected, leaving fixed-income investments more in competition for investor dollars on a risk-adjusted basis.
Gary W. Dyer is the senior portfolio manager for The Sanibel Captiva Trust Company.