My reading of the economic and financial tea leaves is that the economy continues to grow at a sub-par economy pace (about 2%), just as it has for the past 8 years. I don’t see evidence of a coming boom, or of an imminent bust… just more of the same. Dull. Here are a baker’s dozen charts, with the latest updates, to flesh out the story:
The chart above is one of my enduring favorites. It shows that the ISM manufacturing index does a pretty good job of tracking the growth rate of the economy. What’s especially nice is that the index comes out with a relatively short lag of just a week or two, whereas we usually have to wait months to get a read on the economy. What it’s saying now is that GDP growth in the current (third) quarter is likely to be in the range of 2-4% annualized. That won’t necessarily mean that the underlying pace of growth is picking up though; it’s more likely that some faster reported growth in the current quarter which will make up for the relatively weak growth of recent quarters. Such is the volatile nature of GDP stats.
The two charts above are encouraging, since they show that global economic activity is likely picking up. US manufacturers are seeing relatively strong overseas demand, and Eurozone manufacturers have experienced a significant improvement over the past year or so, after years of weak activity.
The chart above shows that US manufacturers are at least somewhat optimistic about the future of their businesses, since many reportedly plan to increase hiring activity in the months to come.
Not surprisingly, faster growth of revenues has gone hand in hand with increased profits. Trailing 12-month earnings per share (earnings on continuing operations) were up over 9% in the year ending July. No wonder the stock market continues to edge higher. Profits and prices are both at all-time highs and rising.
The current trailing PE ratio of the S&P 500 is just over 21, according to Bloomberg’s calculation of earnings from continuing operations. That’s a good deal above its long-term average of just under 17, but it’s not impossibly high. The inverse of the PE ratio—the earnings yield on stocks—is still a healthy 4.7%.
The chart above subtracts the yield on 10-yr Treasuries from the earnings yield on stocks. Equity investing still gives you a yield that is substantially higher than the risk-free yield on Treasuries. It’s not always thus. In fact, during periods of robust growth and strong stock markets—such as the 1980s and 1990s—the earnings yield on stocks was usually less than the yield on Treasuries. When investors are confident and the economy is strong, investors are willing to accept a lower yield on stocks because they expect to more than make up for that with capital gains (i.e., rising share prices). The situation today is quite the opposite: a positive equity risk premium suggests that investors are skeptical of the ability of earnings to grow, and are thus willing to accept a lower yield on Treasuries in exchange for their increased safety.
Not all is rosy, however. As the chart above shows, the dollar has taken quite a hit since the “Trump bump” of last November. It’s down about 10% in the past 8 months, in what is surely a sign that the world has become a lot less excited about the growth prospects of the US economy.
The chart above provides more evidence that the market doesn’t expect the US economy to be very strong going forward. The current real Fed funds rate—the best indicator of whether monetary policy is tight or not—is about -0.25%. The current 5-yr real yield on TIPS (a good indicator of what the market expects the real funds rate to average over the next 5 years) is only 0.11%. This means the market doesn’t expect the Fed to do much more in the way of tightening for the foreseeable future and that, in turn, means the market holds out very little hope for any meaningful improvement in the US economy.
- I see no sign of excessive optimism or pessimism in market prices.
- The market’s expectations are for a dull economy to remain dull and for inflation to remain relatively low. 5-year expected inflation, according to TIPS and Treasury prices are 1.7%.
- There is no compelling reason to worry about a recession, or to get excited about a boom. The market is thus “vulnerable” to signs of emerging weakness or increased strength.
- If we get a decent tax reform package, look for optimism to emerge.
- If we don’t get tax reform, the downside risk is likely not significant, since reform expectations have not been priced in.
- Fortunately, we have had some meaningful reform in the area of regulatory burdens so far this year, and this should give the economy enough of a lift to keep things on an even, 2% growth trajectory or maybe slightly better.
The comments above are edited ([ ]) and abridged (…) excerpts from the original article by Scott Grannis
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