Spaghetti Westerns and the Economy

We hope everyone is enjoying their Summer.  It always seems to go by so quickly.  But lucky for us there is never a dull moment, financially speaking.  This month we will borrow a well-known movie title from spaghetti-western director Sergio Leone to break down recent economic and political events.  Without further ado, we present the good, the bad and the ugly.

Let’s start with the Good.  As we have continued to write for most of the year, the economic fundamentals have been the star of the show.  One example is employment data. One of the more interesting employment reports looks at both the number of people quitting their job and those being laid off, known as the JOLTS report.  This report shows that the number of people quitting their jobs is at record highs while the number being laid off is at record lows.  This shows that workers have the upper hand and are finding better opportunities.  This is a sign of health for the economy that is supported by strong consumer spending.  But at the same time, it is a perfect set-up for wage inflation.  However, we have not yet seen significant increases in wage, and opinions differ on whether we will.  We talked last month about the “technology effect” as one possible explanation for why it hasn’t appeared.  Another possible reason borne out in employment reports is that younger, less expensive workers are replacing the more expensive retiring boomers.

Continuing to focus on the good, we have several additional positives.  Consumer sentiment continues to show relative strength.  Leading economic indicators hit new highs, driven by new manufacturing orders.  We continue to see the impact of the tax cuts and spending increases as company earnings continue to impress.  And finally, we are seeing a very high level of merger and acquisition (or M&A) activity.  To date we have seen 700 transactions worth an estimated $917 billion.  This also points strongly to the positive economic backdrop and outlook as M&A is very sensitive to economic conditions and market volatility. 

The Bad.  While wage inflation, thus far, is in check, we are seeing increases in most broader measures of inflation to normal levels. The Federal Reserve’s preferred measure of inflation recently hit 2%, its target level. This suggests the Federal Reserve will stay on its course of raising rates this year to keep underlying pressures from pushing it up to unacceptable levels.

With trade tensions at the top of the news cycle, it is understandable that consumer sentiment readings, while still at strong levels, have recently experienced a decline.  There appears to be no end of opinions on what should be done about levelling the playing field for countries trading goods and services.  One effect of these tensions is that China seems to be shifting its agricultural purchases from the US to Brazil.  If trade tensions do nothing else, they are certain to redirect global trade flows.

And now for the Ugly: mid-term elections.  It is anyone’s guess as to what the next several months of campaign and news stories from our nation’s capital will bring.  It is clear that President Trump is continuing to focus on trade and immigration.  This has been extremely polarizing and is having a negative impact on markets.  The House, Senate and media outlets will all look to capitalize on any information or position that is believed to benefit their own agenda.  If the last election cycle was any indication, it is anybody’s guess as to what is in store.  Mark Hulbert from MarketWatch points out, however, that since 1957 returns for the S&P 500 Index have averaged 12% during the 6 months following the mid-term elections.

So, there you have our version of the good, the bad and the ugly.  We can’t overstate enough that we are generally positive in our economic outlook.  We do, however, recognize that there are forces that could derail the recent positive market performance.  Inflation, trade and consumer sentiment are all important factors whose fates are intricately linked, much like the iconic trio in Mr. Leone’s classic 1966 movie.   We are looking for the Good to win out in the end.