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Still room to run

steering wheel FEAX

By Bob Landaas

With this bull market more than seven years old, it is natural to question when the good times will be over. Significant market downturns are normally brought on by recessions.

A recession at this point looks unlikely.

  • First-quarter gross domestic product (the broadest measure of U.S. economic output) rose an anemic 0.8%. Forecasts call for GDP to average 2% or more in the coming quarters. In the majority of cases, stock prices improve along with improving economic growth.
  • Almost all recessions are preceded by an oil price spike. That is not the case this time around. Oil remains 35% below a year ago and is still more than 50% below its peak two years ago.
  • Another indicator of recession is a flat or inverted yield curve. Right now, the spread between 2-year Treasuries and 10-year Treasuries is normal.
  • While the slowdown in China remains a concern, it is important to point out that we have never had a U.S. recession caused by an economic slowdown overseas.
  • Many recessions have been caused by a jump in inflation, forcing the Federal Reserve to dramatically increase interest rates. In this current cycle, there is a notable absence of any meaningful inflation. The core rate of inflation rose just 1.6% from a year ago, well below the Federal Reserve target for 2% inflation.

Recent economic reports suggest that the economy is picking up speed from the slowdown last winter. The latest Commerce Department report shows consumer spending rising at the fastest pace in almost seven years. After a six-month lull, we are seeing a solid rebound in consumer spending which, of course, fuels nearly 70% of our economy.

The Commerce Department also reported that durable goods orders rose an impressive 3.4% in April. Also, the Institute for Supply Management’s manufacturing index rose more than expected in May. It was the third straight month of expansion for manufacturing following five months of contraction. A weaker dollar and higher commodities prices have helped the manufacturing sector.

Stocks have finished higher for four months in a row as momentum in the economy appears to be building. The collapse in oil prices served to erase profit growth. Corporate profits are still negative and are not expected to turn positive until the second half of the year. Consensus forecasts are calling for a 14% increase in profits for next year.

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The disappointing labor report for May suggests that there are still significant risks to the outlook. Other headwinds for the economy are the risks of a stronger dollar, slowing exports and limited business spending.

Moreover, the Federal Reserve’s Beige Book, a regional survey of economic conditions around the country, found that growth was uneven. Half of the Fed’s 12 districts reported growth as modest with other districts reporting that growth was slowing or flat.

We never can know for sure what is going to happen or when patterns we have observed in the past will be broken. That is why we practice humility and preach a balanced approach to investing.

With a recession unlikely at this point, though, and with a strong forecast for profits next year, it stands to reason that stocks still have room to run.

Bob Landaas is president of Landaas & Company.

(initially posted June 3, 2016)

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