Orlando's Outlook: Fundamentals still matter

09-13-2018

Bottom Line Stocks corrected earlier this year by more than 11% from their Jan. 26 peak to their April 2 trough, as investors attempted to discount their concerns about leadership transition and monetary policy at the Federal Reserve. Since that sharp correction, however, the S&P 500 has rallied by more than 14% over the past five months to a new record high, fueled by the strongest GDP growth in four years at 4.2% in the second quarter and by another powerful earnings season, with corporate profits up 25% in the first half.

Midterm election years like 2018 tend to be perilous, however, with heightened volatility and mid-year air pockets reflecting market worries. To that point, there’s been no shortage of potential headwinds this summer, such as the Fed’s next policy-setting meeting on Sept. 26; President Trump’s growing trade and tariff war; a stronger U.S. dollar; narrowing yield-curve spreads; rising inflation and oil prices; the potential fiscal-policy impact from a Blue Wave in the elections; a variety of geopolitical risks; and the Mueller investigation’s “black swan” possibility. Yet, stocks have suffered only five relatively minor 2-4% hiccups at various points over the past six months to discount these risks.

So the lesson is that fundamentals still matter most of all, as the market has largely shrugged off and looked through these possible near-term risks in the face of a very constructive longer-term picture. True, we remain in a fundamental vacuum for the next month or so until the next set of corporate earnings and GDP are released during October. But with several of the confidence metrics we monitor sitting at multi-decade cycle highs, a healthy labor market, and strong growth in both consumer spending and manufacturing, we remain confident the S&P will hit our year-end target of 3,100.

Labor market remains solid in August Highlights include nonfarm payrolls, which rose more strongly than expected by 201,000; wages, which soared at their fastest pace in nearly a decade by 2.9%; and the labor impairment rate (U-6), which fell to a new 17-year low at 7.4%. The U.S. continues to wring slack out of the labor market. The Job Openings and Labor Turnover Survey (JOLTS) posted a record 6.939 million openings in July, meaning there are more available positions than unemployed Americans to fill them. Also, a record 3.58 million Americans quit their jobs in July, as the quits rate rose to a 17-year high of 2.4%. Initial weekly unemployment claims fell to 203,000 for the week that ended Sept. 1, a new 49-year cycle low.

Confidence strong While many confidence metrics we follow are at or near multi-decade cycle highs, these four top the list:

  • Leading Economic Indicators (LEI) index has now increased sequentially for 23 consecutive months to July 2018’s 110.7, an all-time, 58-year cycle high.
  • Conference Board’s Consumer Confidence Index surprisingly soared to a new 17-year cycle high of 133.4 in August 2018, as post-election confidence has surged from a cycle trough of 100.8 in October 2016.
  • National Federation of Independent Business (NFIB) small-business optimism index rose sharply from a cycle trough of 94.1 in September 2016 to a surprisingly strong 108.8 in August 2018, an all-time 44-year high.
  • ISM manufacturing index surged to a much stronger-than-expected 14-year high of 61.3 in August 2018, up sharply from a contraction reading of 49.4 in August 2016.

Retail sales on a roll We enjoyed the best Christmas retail sales season in five years in 2017, followed by the best “Mapril” results in six years, and what appears to be the early stages of a strong Back-to-School (BTS) season from July through September. To be sure, a strong Easter and spring were followed by a soft June, as consumers hunkered down for a month to collect some dry powder ahead of the important BTS season. But nominal retail sales in July were flashed at a better-than-expected month-to-month gain of 0.5%, with control results in July up 0.6%. Because the consumer accounts for 70% of GDP, this strong spending should help to boost economic growth in the third quarter.

Raising our GDP forecast The equity and fixed-income investment professionals who comprise Federated’s macroeconomic policy committee met on Wednesday to discuss the strengthening economy.

  • The Commerce Department revised second-quarter GDP up a tick to 4.2%, versus 2.2% in the first quarter. The final revision will be released Sept. 27.
  • Due to the healthy labor market, elevated confidence and strong consumer spending and manufacturing activity, we are increasing our third quarter 2018 GDP estimate from 3% to 3.4%, while the Blue Chip consensus is raising its estimate from 2.9% to 3.1% (within a range of 2.6% to 3.7%). The Atlanta Fed’s widely followed GDPNow model is now at 3.8%.
  • Hurricane Florence’s assault on the Carolinas this week is estimated to be twice as damaging as Harvey’s destruction of Houston last year, which means that an economically stimulative rebuilding program will begin in the fourth quarter. In conjunction with our expectations for a strong Christmas, we are raising our fourth quarter 2018 GDP estimate from 2.8% to 3.3%, while the Blue Chip consensus remains unchanged at 2.8% (within a range of 2.2% to 3.3%).
  • So we are raising our full-year 2018 GDP estimate from 2.9% to 3%, while the Blue Chip consensus remains unchanged at 2.9% (within a tight range of 2.8% to 3.1%).
  • We are initiating our first quarter 2019 GDP estimate at 2.9%, versus the Blue Chip consensus at 2.4% (within a range of 1.7% to 3%).
  • We are initiating our second quarter 2019 GDP estimate at 3%, versus the Blue Chip consensus at 2.5% (within a range of 1.8% to 3.1%).
  • We are initiating our third quarter 2019 GDP estimate at 2.4%, versus the Blue Chip consensus at 2.2% (within a range of 1.5% to 2.9%).
  • We are initiating our fourth quarter 2019 GDP estimate at 2.4%, versus the Blue Chip consensus at 2% (within a range of 1.1% to 2.7%).
  • We are raising our full-year 2019 GDP estimate from 2.9% to 3%, while the Blue Chip consensus remains unchanged at 2.6% (within a range of 2.1% to 3%).

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