U.S. Economy: Current Expansion Among the Longest in Post-War Era
The pace of economic growth in the U.S. slowed somewhat in the first quarter with inflation-adjusted (real) gross domestic product (GDP) increasing by 2.3%, according to the advanced estimate released in late April by the Commerce Department. The economy grew by 2.9% in the fourth quarter of 2017.
While the pace of growth may have slowed during the first quarter, the current economic expansion in the U.S. is poised to become among the longest in the post-war era (see below).
The Commerce Department said the deceleration in real GDP growth reflected lower consumer spending – indeed, personal consumption expenditures (PCE) were the lowest in almost five years – as well as a deceleration in residential fixed investment, federal government spending, and state and local government spending. That was partly offset by an upturn in private inventory investment, while imports – which are subtracted in the GDP calculation – decelerated.
While consumers spent less – PCE was up 1.1% compared to 4.0% in the fourth quarter – they did have more money in their pockets. Real disposable personal income increased 3.4%, compared to an increase of 1.1% the previous quarter. In addition, the personal savings rate, or personal savings as a percentage of disposable personal income, was up 3.1%, compared to 2.6% in the fourth quarter.
But How Does the Current Expansion Stack Up to Others?
In May, the current economic expansion became the second longest in the post-war period as it reached the 107-month mark. Still, real (inflation-adjusted) GDP has lagged the previous three longest post-war expansions due to factors such as restrained consumer spending and lower real private fixed investment, according to an Insight article published May 9 by FactSet.
Overall, real GDP as of the first quarter has expanded by 21% since the beginning of the current expansion. That compares to the 36% compound growth at the same point of the 1991- 2001 expansion. FactSet’s research also points out that the growth path of the longest expansions has slowed over time. Real GDP had grown by 52% by the end of the ninth year of the 1961-1969 expansion, but by only 38% by the end of year eight of the 1982-1990 expansion.
Preceding the current expansion was the housing market crash, then the Great Recession, which appears to have had a lasting impact on consumers’ ability and willingness to spend during the economic recovery, FactSet says. The consumer was definitely hit hard, with households losing up to 19% of their net worth over the course of two years (including the months leading up to the officially-defined recession period).
Indeed, inflation-adjusted, or real, personal consumption (roughly 70% of GDP) has grown by just 23% since the summer of 2009, compared to growth rates of 41% and 50% at the same point in the expansion of 1991-2001 and 1961-1969, respectively, according to FactSet.
And despite the low interest rate environment during this expansion (10-year note yields have, on average, remained nearly 400 basis points below rates during the 1991-2001 expansion), investment outside of the housing market has continued to lag. Real private fixed investment has grown by 50% in this expansion, compared to growth rates of 89% and 76% at comparable points in the 1991-2001 and 1961-1969 expansions, respectively, according to FactSet.
Though debatable why, FactSet notes that the housing market hangover led to businesses shedding debt, while banks were reluctant to loan. Additionally, oil prices collapsed from a peak of nearly $107 per barrel in June of 2014 to a low of nearly $53.50 a barrel by the end of the year – impacting energy extractors, and the oil industry and the network of upstream suppliers.
Back to the consumer, the slow recovery of the labor market as the expansion got underway has been another factor influencing the consumer’s reluctance to spend. The pace of job growth was also slow during the 1991-2001 expansion, though that expansion averaged nearly 300,000 new jobs each month by its third year, compared to the current recovery in which the monthly average didn’t top 200,000 per month until its fifth year, according to FactSet.
The current pace of job growth, though, has accelerated in the past several months of the current recovery, with the Labor Department reporting in early May that the unemployment rate fell in April to 3.9% – its lowest since December 2000. Seasonally-adjusted nonfarm payrolls increased by 164,000, and average hourly earnings rose by 4 cents from the previous month to $26.84, and by 67 cents compared to a year ago, or 2.6%.
Real Estate: Demand Remains Amid Inventory Mismatch
While recent data like the April jobs report and first-quarter GDP point to signs that the economy continues to chug along, the housing market’s spring selling season is off to a slow start. Low inventory and rising prices are keeping would-be buyers sidelined – particularly as a greater percentage of homes available are in the higher-end of the market.
Existing home sales increased by 1.1% in March compared to the previous month to a seasonally-adjusted rate of 5.6 million, according to the National Association of Realtors. Compared to a year ago, sales were down by 1.2%.
Sales are lagging “because supply is woefully low and home prices keep climbing above what some would-be buyers can afford,” Lawrence Yun, the NAR’s chief economist said in the press release announcing the latest figures.
“There’s a serious mismatch in the U.S. housing market right now: The majority of homes available to buy aren’t the kind of homes the majority of buyers are seeking. And the limited inventory of those more sought-after homes is contributing to their more rapid appreciation,” Svenja Gudell, Zillow Group’s chief economist, said in the March Zillow Real Estate Market Report.
Compared to a year ago, the total inventory of homes for sale fell 8.6% in March – the 38th straight month of annual inventory declines, according to Zillow. More than half, or 51.4%, of homes for sale nationwide were in the most expensive one-third of the market, with only about one in five, or 21.9%, in the entry-level, bottom third.
Inventory in the latter segment is also falling faster – 15.3% lower year-over-year – yet prices are accelerating, with the median price for the entry-level, bottom third segment of the market rising in value by 11.5% over the past year.
According to NAR figures, the median existing home price for all housing types in March rose 5.8% year-over-year to $250,400. “Although the strong job market and recent tax cuts are boosting the incomes of many households, speedy price growth is squeezing overall affordability in several markets – especially those out West,” said Yun.
As the chart below shows, 30-year fixed mortgage rates are up by 50 basis points from a year ago, but leveled off from the previous week. Freddie Mac notes that while higher rates have put pressure on the budgets of some home shoppers, weak inventory levels are what’s keeping the housing market from a stronger sales pace.
Freddie Mac does expect that increased construction of new homes will help reduce the pressure on home price appreciation and sales are holding up despite the higher mortgage rates compared to last year. Housing starts picked up in the third quarter of 2017 – implying that new homes for sale will be on the market in the coming months, it said in its April outlook for the housing market.
On the construction side, the National Association of Home Builders says its members continue to face supply-side constraints, including a lack of available lots to build on and increasing costs for construction materials. Tariffs on Canadian lumber and other imported products are also pushing up prices and hurting affordability. Builders do remain confident, however, given the strong demand for housing, despite a one point dip to 69 in the National Association of Home Builders/Wells Fargo Housing Market Index (HMI), released in mid-April.
“Ongoing employment gains, rising wages and favorable demographics should spur demand for single-family homes in the months ahead,” said NAHB Chief Economist Robert Dietz in the April 16 press release.
Stock Markets: Energy Sector Rallies, Small Caps Still Outperforming
Higher oil prices, which pushed the energy sector up by more than 9.0%, and the beginnings of a shift to defensive sectors like health care and utilities, led to the S&P 500 posting a monthly gain of 0.27% in April. While that may have been underwhelming for the S&P 500 index as a whole, it did represent the first monthly gain for the index since January. The Dow Jones Industrial Average, meanwhile, was up by 0.25% in April, while the Nasdaq Composite index rose by only 0.04%.
Looking closer at the S&P 500, there was wide variance in the monthly performance among the index’s 11 industry sectors. As mentioned above, the energy sector was up by 9.3%, and has gained nearly 2.1% year-to-date. Sustained strength in oil prices (see more in the Commodities section), and improved balance sheets bode well for energy shares.
“Energy is not often thought of as defensive or stable. However, with oil prices breaking higher, and oil companies exhibiting more capital discipline and relatively high yields in many cases, it’s well position to play its classic late-cycle role with a defensive kicker,” Michael Wilson, Morgan Stanley’s chief U.S. equity strategist and chief investment officer, said in a May 2018 research report.
The energy sector joins consumer discretionary shares (up by 5.1%) – which continue to perform well, despite rising interest rates – and information technology (up more than 3.2%), as the only sectors within the S&P 500 that have posted gains since the beginning of the year. (The monthly and year-to-date performance recap for the S&P 500, S&P MidCap 400 and S&P SmallCap 600 are available here.)
As has been the case in recent weeks, small cap stocks outpaced those of larger caps. The S&P SmallCap 600 gained 0.96% in April and is up 1.2% since the beginning of the year. The broader Russell 2000 rose by 0.81% in April and is up 0.42% year-to-date. Part of the story has been a resurgent U.S. dollar – which tends to help smaller companies with more domestic exposure outperform larger multinational firms.
Small-cap stocks tend to have little in the way of international exposure, they tend to be a big beneficiary of dollar strength, according to Bespoke Investment Group. Since the close of April 16, the U.S. Dollar Index is up by 4.1% through May 8.
Evidence that dollar strength is having some impact on stock performance is evident in a closer look at companies within the Russell 1000 Index. Russell 1000 stocks that generate more than 50% of their revenues outside of the U.S. are down an average of 1.21% since April 16. In contrast, Russell 1000 stocks that generate all of their revenues domestically are up an average of 1.67% over the same time period, according to Bespoke Investment Group.
Weaker Currencies Lead to Higher European, Japanese Equities
Signs that inflation remains somewhat subdued in Europe and Japan may give pause to the normalization of accommodative monetary policy by the European Central Bank and Bank of Japan. Weaker currencies – the euro and yen have been depreciating in recent weeks – and an uptick in corporate earnings have benefited European as well as Japanese equities since the end of the first quarter.
In Europe, the MSCI Europe Index gained slightly more than 4.0% in April (on a price return basis), outpacing the MSCI World Index, which was up 2.8%. European shares had been lagging behind the MSCI World Index but recently caught steam as higher oil prices and a weakening euro are expected to benefit those multinational and exporting companies that have large weightings within the MSCI Europe Index.
While the amount of companies in Europe reporting earnings that are beating analysts’ expectations is not nearly as strong as it has been during the first-quarter earnings season in the U.S., stronger corporate earnings have helped partly dispel concerns that the eurozone economy is beginning to slow.
First quarter earnings for companies in the STOXX Europe 600 index are expected to increase 4.1% compared to the same period a year ago, according to Thomson Reuters I/B/E/S. As of May 8, 192 companies in the STOXX 600 had reported first quarter earnings, with 49% exceeding analysts’ expectations. In a typical quarter 50% of companies beat analyst earnings-per-share estimates.
Still, Deutsche Bank’s equity strategy team noted in this report that it expects more companies to beat analysts’ targets, based on its model which tracks moves in the euro, commodities and global macro surprises.
In Japan, the MSCI Japan Index, which tracks 321 companies, gained nearly 3.6% in April (in local currency terms). The Nikkei 225 was up by 4.7% for the month. While a weaker yen has helped, Japanese corporate earnings aren’t nearly as dependent on a depreciating yen as they had been in the past.
“Japan’s current phase of earnings growth is being driven largely by internal factors, such as growing private capital expenditure and domestic consumption,” Yunyoung Lee, Janus Henderson Investor’s manager of Japanese Smaller Companies Strategy, said in a March 2018 report.
The case for Japanese stocks is bolstered (on a macro level) by expectations that the Bank of Japan will hold off on normalizing monetary policy, and (at the company level) by the cash on the balance sheet. Corporate reform, the Janus Henderson report said, is being boosted by the increasingly large cash piles of Japanese companies, “indeed this is providing ample opportunities for shareholders to benefit from rising dividend payments and share buybacks.”
Commodities: Price Inflation Pressures Bond Yields, Companies’ Margins
Oil prices, which moved past $71 a barrel on May 9 for the first time since late 2015, are not the only commodity on the rise. Higher aluminum and steel prices are contributing to margin pressures for a growing list of U.S. companies. The bond market has also taken note as commodity price inflation has been among the factors pushing yields higher.
After ending March with a yield of 2.74%, the 10-year Treasury note pierced through the 3.00% yield level in late April, finishing the month about 21 basis points higher at 2.95%. Any sustained commodity price inflation could also set the Federal Reserve on a more aggressive path of raising interest rates – a worry for bond investors.
Recent data show that core inflation, excluding food and energy, is still below the Fed’s 2.0% target. It rose 1.9% in March compared to a year ago, based on the personal consumption expenditures price index, compiled and published by the Bureau of Economic Analysis.
Nevertheless, the spike in oil, metals and other commodities prices is expected to impact companies’ earnings in the upcoming quarters. Companies including Caterpillar, 3M, Kimberly-Clark, Whirlpool and Proctor & Gamble cited higher commodity, raw materials or transportation costs during their recent quarterly earnings conference calls. Other companies also noted inflationary pressures, according to this report in late April.
Commodity prices caught fire in April after the U.S. announced sanctions on Russian companies and their owners. Even though the start of sanctions was delayed, prices for a range of important industrial metals kept climbing. Aluminum prices hit their highest level in six years in mid-April, while nickel and palladium prices have also risen. The Bloomberg Commodity Index was up 4.6% through April – from its low in early February when global markets were experiencing extreme volatility.
As for oil prices, the recent decision by the Trump Administration to exit the 2015 Iran nuclear deal has cast another unknown on the geopolitical front. West Texas Intermediate crude closed on May 10 at $71.36 a barrel. The potential for lower exports from Iran could impact tighter supplies – the result of the Organization of the Petroleum Exporting Countries’ (OPEC) agreement with its members and big producers outside the cartel to cut daily output.
Sources for Financial Data:
Dow Jones Industrial Average:
U.S. Dollar Index:
Bloomberg Commodity Index:
West Texas Intermediate Crude:
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