Second Quarter 2018: Unique But Not Different

For much of this recovery and expansion, many have opined that this economic cycle would ultimately end very differently than those of the past. We have resisted this narrative and instead explained our belief that this cycle will indeed follow the same path and end like all others. We contend that it is just taking longer to get to each of those “milestone points” along this path because the scars of the Great Recession were deep. As a result, both business owners and consumers have behaved more moderately and, from a political perspective, every action was focused on making the world safer. Now these scars appear to be healing. With another quarter in the books, we believe the preponderance of the evidence points to a U.S. economy that is pushing down a familiar path that is similar to those of the past.

Indeed, the biggest “abnormality” those who believe this time is different have evidenced is that inflation has remained constrained. We believe this narrative is changing and looking more normal. Indeed, during the second quarter, the U.S. Core Personal Consumption Expenditures Price Index hit the Federal Reserve’s 2-percent target for the first time since 2012. And we believe that forward-looking measures of inflation continue to point higher as economic growth strengthens. While these rising inflationary pressures will be a growing risk, we continue to believe that the Federal Reserve will act with a velvet touch regarding interest rate hikes.

Economic Growth is Finally Broadening

Real time economic indicators continue to point to more – not less – economic growth. For many years, the U.S consumer did the heavy lifting while business investments and the manufacturing sector were lackluster. That is no longer the case. Indeed, the Institute for Supply Management (ISM) Manufacturing Index continues to post robust readings. Importantly, much of this optimism is being generated by new orders entering factories, which historically are leading indicators of continued future economic growth. June 2018 marked the 14th straight month (and 17th out of the past 18 months) that new orders were above 60. A reading above 50 means expansion, with a reading above 60 denoting robust expansion. A review of history reveals that this level of new order growth often occurs near the beginning of an economic cycle, not at the end of a cycle or, worse yet, right before a recession.

Economic optimism has also broadened to include “Main Street America” and small business owners. During the quarter, the National Federation of Independent Business Owners Index hit its second highest level in its 45-year history, with the only higher print occurring in 1983. Interestingly, another variable that many use as evidence of the new normal is that wage growth has remained lackluster. We note that in this report, actual compensation hit a 45-year high, with similar record highs made on earnings and expansion plans.

We believe this cycle is progressing along a path similar to those of the past, but at a slower cadence. And given our belief that recessions cause market declines, we paint a picture of continued economic growth and positive market returns.