economic perspective

December 2019

  

By Thomas Dillman

As 2019 draws to a close, Mutual of America Capital Management LLC explores the impact that some recent events in the United States and across the globe are having on the financial markets and the prospect for sustained economic growth during 2020.

All Is Not Quiet Before Year-End

Since hitting its most recent low of 2,887.61 on October 2, 2019, the S&P 500® Index advanced nearly 10% through mid-December. The Index is up more than 26% for the current year, but only about 8% since the 2018 high mark of 2,930.75 achieved last September 20. The difference is due to a 14% correction during the fourth quarter of 2018 over fears the U.S. Federal Reserve had gone too far in raising interest rates. Three quarter-point cuts by the Fed during the current year mitigated those fears, contributing in large part to the full year's advance in the U.S. markets. This year's fourth quarter advance is attributable to the market's anticipation of the remarkable confluence of three positive events of the second week of December, all combining to significantly reduce the uncertainty that prevailed over the previous two years.

  • First, the Fed made clear in its December post-meeting announcement that there would be no further rate changes for the foreseeable future, contingent on the trend of future economic data.
     
  • Second, British parliamentary elections yielded an overwhelming victory for Prime Minister Boris Johnson and his Conservative Party. This assured him the votes to push through Great Britain's exit from the European Union (Brexit) with or without a specific deal, ending a long-standing stalemate that created confusion, prompted many businesses to leave Britain and froze business decision-making both in Great Britain and in Europe.
     
  • And third, the Trump administration scored a trifecta of wins on trade, including: an agreement with House Democrats on the revised North American Free Trade Agreement (NAFTA), now called the United States-Mexico-Canada Agreement (USMCA); the completion of a "phase one" trade agreement with China that rolls back some U.S. tariffs in exchange for increased agricultural purchases from China, as well as commitments on intellectual property rights, forced technology transfer, currency markets and enforcement mechanisms; and, the effective emasculation of the World Trade Organization's trade conflict appeals process by refusing to approve new appointments to the court.

Also, little noticed in the midst of these major announcements, was the agreement between Democrats and Republicans on a budget for the current fiscal year, avoiding the bipartisan brinksmanship typical of budget negotiations in the past that led to partial government shutdowns.

Impeachment Impact on U.S. Economy Remains Uncertain

However, the steady progression by the House of Representatives leading up to and culminating with its impeachment of President Trump on December 18 for high crimes and misdemeanors on the two articles of impeachment – namely, abuse of power and obstruction of Congress – stood in stark and threatening contrast to the abundance of positive news on the macroeconomic front. The process of impeachment moves next to the Senate, which is empowered by the Constitution to conduct a trial on the articles of impeachment. The Senators act as jurors and the Chief Justice of the United States presides over the trial. The Constitution requires a vote of at least two-thirds of the 100-member Senate on at least one article of impeachment to convict and remove the president from office. Given the slight Republican majority in the Senate, the two-thirds vote requirement renders removal unlikely according to political analysts. However, the timing of any trial and the setting of its rules remain both uncertain and subject to considerable political wrangling as of the time of this writing.

Economic Data a Mixed Bag

Meanwhile, strategists and economists who largely remained hopeful that the slowdown in the U.S. expansion over the past year would bottom and rebound cyclically sound increasingly convinced this rebound will occur. However, there appears to be little improvement in recent economic data to justify their enthusiasm. Except for consumer spending, employment and housing, the Gross Domestic Product (GDP) for the third quarter was 2.1%, ahead of expectations of 1.9%, but flat versus 2.0% during the second quarter. The manufacturing sector continues to struggle. U.S. non-financial capital expenditures registered only 1.2% year-over-year in the third quarter of 2019.1 Durable goods and factory orders both declined in October, while the ISM Manufacturing PMI surveys declined in both October and November. The ISM Non-Manufacturing PMI surveys improved in October, then receded modestly in November, but remains above 50. Similarly, with 95% of corporate earnings reported for the third quarter, the year-over-year growth in earnings is down 1%. Although growth is 2% ahead of expectations, this marks the third quarter in a row of essentially flat earnings.

On the positive side, the November jobs report showed 266,000 new jobs added versus expectations for 178,000, while the prior month's number was revised upward by 28,000 jobs. The unemployment rate ticked down to its historical low of 3.5%. In the meantime, inflation remains well contained around the Fed's target of 2.0%. The November CPI core index, which excludes food and energy, registered 2.3% year-over-year, the same as in October. The Fed's preferred inflation measure, the Personal Consumption Expenditure Price Index (PCEPI) registered a year-over-year rate of 1.6%, down slightly from expectations and the prior month's 1.7%. Given that the Fed's dual mandate is to provide full employment with stable prices, it is performing very well by these standards.

Global Economy Sluggish, with Signs of Life

Several recent global economic statistics have been dismal. For instance, German exports declined 6% in October following a downturn of 2% the prior month, and factory orders have declined year-over-year for 17 consecutive months.2 In Japan, machine tool orders declined 6%. China's GDP for the third quarter of 2019 moved at its lowest pace in over two decades, at 6.0%. That said, there are growing signs that these downward trends are bottoming and beginning to reverse. The ISM Manufacturing PMIs for Europe improved modestly in November. The PMI for the Eurozone rose from 46.6 to 49.9, with Germany's increasing from 43.8 to 44.1 (better but not good) and France's from 50.7 to 51.7. China's November PMI moved up from 49.3 to 50.2, while Japan's advanced from 49.1 to 49.8. None of these recent numbers is particularly impressive, all hovering around the divide between growth and non-growth, but the trend is positive, following consistent declines over most of the past 12 to 18 months. The common factor to these trends in manufacturing data is exposure to global trade, which has slowed during the trade war between the U.S. and China. The anticipation of de-escalation in this ongoing issue may explain the recent modest improvement in global PMIs, much as rising expectations of a deal fueled the recent strong advance in stocks, not just in the U.S., but in most other markets across the globe.

Outlook

Recession fears have receded, but much of the recent good news is already reflected in stock valuations. The entire recent advance was based on Price/Earnings (P/E) expansion, not earnings growth. Based on current expectations of U.S. GDP settling into an average growth pace of 2.0%, modest recovery in growth abroad and easy earnings comparisons over the next year, the current P/E bubble should be corrected with a modest advance in earnings in 2020. Unless the new cyclical uptick is realized and proves surprisingly robust, it is difficult to imagine stocks as a whole advancing significantly next year, especially following the powerful bull market rally of 2019.

Thomas Dillman is the former President of Mutual of America Capital Management LLC.

1

FRED Economic Data, Board of Governors of the Federal Reserve System, November 2019.

2

FHN Financial AM Economic Comments, Chris Low, December 5, 2019.

The views expressed in this article are subject to change at any time based on market and other conditions and should not be construed as a recommendation. This article contains forward-looking statements, which speak only as of the date they were made and involve risks and uncertainties that could cause actual results to differ materially from those expressed herein. Readers are cautioned not to rely on our forward-looking statements.

Mutual of America Capital Management LLC is an indirect, wholly owned subsidiary of Mutual of America Life Insurance Company. Mutual of America Life Insurance Company is a registered Broker-Dealer.




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