Third Quarter 2019

During the second quarter, stocks climbed to new highs and bonds strengthened as Fed Chairman Jerome Powell signaled that the days of easy money are not over.  Its primary objective … sustained economic expansion now and in the foreseeable future.

All eyes on the Fed …

At its July 31st meeting, the Fed is widely expected to lower its key interest rate by ¼ of 1% in an attempt to further extend the expansion into the poorest segments of our society, namely, minority and rural communities.  Although demand for workers is surging and real wage growth is emerging, those at the lower end of the economic spectrum are benefitting the most … people who have been left behind in prior recoveries.     

According to the Bureau of Economic Analysis, employee compensation rose by 4.5% in 2017, 5.0% in 2018 and 3.4% in the first half of 2019.  And, not only are Americans earning more, they are saving more (8.1% in May 2019), helping to put families on a more stable financial footing

By lowering interest rates, the Fed aims to maximize employment and sustain economic growth of 2% or more annually.  But, this strategy is not without risk.  While some Fed members believe they can afford to “rev” the economy because inflation remains tame, others believe inflation may be percolating just below the surface and have raised concern that lowering rates

According to the National Bureau of Economic Research, the current expansion is now the longest on record at 121 months, besting the March 1991-March 2001 expansion by one month.  However, until recently, it’s also been the weakest with cumulative GDP growth of only 25%.  The recent strength is largely attributed to tax cuts and the slashing of government regulations. might encourage speculative borrowing and asset bubbles down the road.  It is important to monitor how this unfolds.

So, how long can the expansion last? 

Generally speaking, there are four phases in an economic cycle … recession, recovery, growth and decline.  Although it’s showing a few weaknesses (trade tensions being one), most investors do not believe the economy is on the verge of overheating or recession.  And, most are hopeful pending interest rate cuts will offset any weaknesses that exist.   

Without doubt, this expansion is quite “aged” by historical standards.  But, it’s not over until it’s over, and it may be far from over.  For now, we remain firmly in the growth phase. 

On the global front …

Trade tensions with China remain unresolved.  But, it’s important to understand this.  For decades, U.S. technology and trade secrets have been stolen by China.  Further, its state-sponsored companies have dumped steel and other products into the global markets at a loss in an effort to drive their privately-owned competitors out of business.  This has cost domestic corporations untold billions in profits and U.S. workers jobs.  To level the playing field, you need to take action when the economy is strong enough to withstand the short-term pain (and there is some pain involved).  The current administration believes the time is now.  To help blunt the pain, it’s offering economic aid to U.S. farmers.  And, that’s another reason the Fed is poised to lower interest rates. 

In recent weeks, Iran shot down a U.S. drone and seized two British cargo ships in the Strait of Hormuz, and North Korea resumed its missile testing program.  It’s no secret both countries are developing nuclear weapons and missile systems.  And, it’s no secret Russia remains an obstacle in negotiations with the former and China in negotiations with the latter.  Clearly, global sanctions are impacting Iran and North Korea but long-term resolutions are elusive.

Following the ouster of Theresa May, Conservative Boris Johnson was elected British Prime Minister in a landslide victory, promising to exit the European Union (EU) by October 31st with or without an immigration and trade deal.  Given the time horizon, it’s now widely expected to be a “no deal Brexit”.  In short, this means current immigration and trade deals will become void overnight.  For example, EU residents will no longer freely cross UK borders, instead they will pass through border crossings subject to immigration checks.  Same for goods imported from the EU, which will become subject to customs inspections and duties.  And, exports to the EU will become subject to trade terms set by the World Trade Organization until trade agreements can be reached with each EU country.  Although many say a no deal Brexit will disrupt business and lead to recession, others say these risks are overblown.  But, watch for the current administration to step-in with an attractive offer for this key trading partner. 

 

 

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