As the first half of 2016 draws to a close, investors are assessing the odds for economic growth to rebound from the first quarter’s surprisingly weak GDP report. We have seen a variety of forecasts which indicate that the second quarter is likely to produce GDP growth between 2-3%, with the full year 2016 perhaps in the range of 2% to 2.5%.
On June 14, the Federal Reserve tamped down investor expectations a bit by indicating their caution on the economy, having been spooked by the much weaker than expected May payroll report, as well as their own Labor Market Conditions Indicator, which has been declining since October. We have observed that even in what were historically very strong years for employment growth, there have been months where the reported monthly payroll figure was surprisingly bad, and indeed it can be a very volatile number. We know, for example, that the recently resolved Verizon strike negatively impacted the May payroll report, though in itself the strike did not account fully for the weakness. Other one-time events, such as bad weather, can also negatively impact monthly results.
Many market observers are quick to point out that the current bull market is in its seventh year, with the implication that this one, the third longest in history, may have run its course. One hallmark of this particular economic expansion is that there has been a surprising lack of capital investment relative to past cycles, whether in new buildings, equipment, factories, or software. In a more typical cycle, we see companies invest in capital goods as the economy expands, then realize too late that there is overcapacity relative to market demand, and some sort of rationalization must then occur. While this cycle’s lack of investment has made life difficult for companies producing those capital goods, we think an important potential benefit is that the economic expansion may last longer than in prior cycles.
So while this particular cycle may be getting long in the tooth, we do not see any imminent signs of its demise. Nevertheless, one of the metrics that may foretell an economic slowdown or recession is a negative inflection in the pace of job growth – which is why many investors were spooked by the May payroll data, even though we all know it can be quite volatile and subject to revision. As a result, we will be closely analyzing labor market data releases over the coming weeks. Our base case is that May was an aberration and June will most likely revert to a more normal level of hiring activity, in line with trends earlier in the year. The following chart depicts the pace of job creation as measured by the ADP (Automatic Data Processing) National Employment report (a private hiring survey) and the Bureau of Labor Statistics’ Nonfarm Payrolls report (a government survey), using the revised data and a 6-month moving average to help smooth out single period volatility.
Both the ADP and BLS employment reports indicate a slowing in the pace of hiring activity, with a more noticeable deceleration in the BLS report. It’s worth repeating that the data series is very volatile and subject to revision, which is why we want to focus on trends rather than a single data point.
If our base case turns out to be incorrect, and the economy is indeed shifting into a slower growth environment, then investors face increased risks that exogenous events can change the trajectory of growth enough so as to cause a potential recession, or period of negative growth. While such events typically are not enough to upset a faster growing economy, with slower GDP growth that has sometimes been referred to as “stall speed”, any drop in confidence by consumers and/or businesses can cause a pause in spending that could be enough to stall economic growth.
In our view, if economic growth remains somewhat lackluster and the Fed continues to push out the timing of interest rate hikes, investors are likely to continue to seek out stocks that provide better than market dividend yields and/or lower than market levels of volatility. As we assess the economic tea leaves in the coming weeks, and economic growth appears resilient, then our portfolio will stay the course we had embarked upon earlier in the year with a shift toward value stocks. If we judge that growth is unlikely to rebound, then we may shift gears and move in the direction of higher yielding and lower volatility stocks that could act as safe havens in a lower growth environment.
This information is intended solely to report on investment strategies and opportunities identified by Roosevelt. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. References to specific securities and their issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Please contact us at 646-452-6700 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions, or if you would like to request a copy of our Code of Ethics. Our current disclosure statement is set forth on our Form ADV Part II, available for your review upon request, and on our website, www.rooseveltinvestments.com.