posted on June 4th 2015 in Market Commentary with 0 Comments /

Two steps forward. One step back.

Did you know that the economic recovery is nearly six years old? That’s right the Great Recession ended in June 2009, which means the economy pulled out of its nosedive and began to climb higher the next month. That is what the National Bureau of Economic Research, which is the official arbiter of the business cycle, reported several years ago.

When we tell clients from time to time that the economy has been expanding since late 2009, I sometimes get a blank stare that screams disbelief.

We get it. We fell into a deep economic hole or what could be thought of as a deep freeze.

When the temperature plummets to zero, the first upticks to one, two, five or even ten degrees don’t feel much like a warming trend, especially if it is cloudy and windy outside.

That paints a good picture of the first few years of the expansion. Much like a meteorologist who monitors various gauges and can pinpoint small changes in the weather, economists sift through all kinds of economic data which have confirmed the improvement in the economy.

Much like the small warm up, it doesn’t mean the average person feels any better about his or her financial security.

While the economy is larger than it has ever been (Bureau of Economic Analysis), a record number of Americans are working (Bureau of Labor Statistics), and the major market indexes have climbed to new highs, many Americans still feel a bit queasy about the economic outlook.

Whether it’s about job security, weak wage gains, retirement issues, or something related, confidence has been slow to return.

Market Performance

MTD %

YTD %

3-year* %

Dow Jones Industrial Average

0.95

1.05

12.70

NASDAQ Composite

2.60

7.05

20.87

S&P 500 Index

1.05

2.36

16.51

Russell 2000 Index

2.16

3.47

17.06

MSCI World ex-USA**

-1.33

5.86

11.59

MSCI Emerging Markets**

-4.16

5.01

3.48

Source: Wall Street Journal, MSCI.com, *Annualized, **USD

A shift in 2014

It wasn’t until 2014 that economic growth finally began to generate a respectable number of new jobs.

According to the Bureau of Labor Statistics, following a bitterly cold winter that took a toll on the economy, growth quickly snapped back and payroll growth exceeded 200,000 for 12 months straight. It was a streak that hadn’t been matched since the 1990s.

In the third quarter of 2014, GDP, which is the broadest measure of economic activity, posted a healthy annualized advance of 5.0%, and it seemed like we were off to the races.

But like so many times before, the economy downshifted in the following quarter and actually contracted in Q1 of 2015.

Nowhere is this more evident than in lackluster retail sales and manufacturing, which are two key economic indicators.

Starting last December, retail sales have disappointed in four of the last five months (U.S. Commerce Department), and industrial production has fallen for five months straight (Federal Reserve). It’s like the economy hit a brick wall.

Then there is one other important indicator the Chicago Fed National Activity Index. It’s not a household name, but it’s quite comprehensive. According to the Federal Reserve Bank of Chicago, the index is a weighted average of 85 monthly indicators of national economic activity.

It shows the latest economic soft patch has been much more pronounced than last year’s weakness, caused by 2014’s brutal winter. And the economy has been slower to bounce back this time around.

Some economists, including Fed Chief Janet Yellen, believe the slowdown was largely due to temporary factors, including cold weather in parts of the country and the since-resolved port slowdown on the West Coast.

Her opinion matters because it’s unlikely that we’ll get any rate increases without a nod from Yellen.

But put two or more economists in a room and you’ll likely get a variety of opinions.

According to the minutes from the April meeting by the Fed, a number of Fed officials believe the negative impacts on the economy from the strong dollar (exports) and cutbacks in energy investments “might be larger and longer lasting than previously anticipated.”

One thing that’s for sure, most consumers have chosen to pocket the mini-windfall they’ve received from lower gasoline prices. It’s a surprise to most analysts, who had expected the savings to be spent elsewhere.

Yet, the sharp decline in oil prices has forced big cutbacks in spending and layoffs by oil companies. Meanwhile, the strength in the dollar has hampered exports.

The sun is trying to peek through

It’s not all gloomy. While the slowdown in economic activity caught most economists off guard, there are few signs we’re slipping into a recession, and leading indicators suggest a pick-up in growth is on tap.

For starters, stocks have held up quite well recently, suggesting that investors are expecting the lackluster performance will eventually give way to firmer growth.

The same can be said of the bond market. Just look at longer-term Treasury yields. While there is little to cheer about a 10-year yield that’s hovering near 2%, we’re not hitting new lows, which would be a sign investors are taking refuge in the safety of Treasuries. Government bonds have historically been an economic safe-haven when an economic downturn approached.

The opposite holds true for high-yield debt, popularly called junk bonds. Since firms that are on the “credit bubble” will have a harder time servicing their debt than a company with an investment grade rating, we typically see junk bond yields jump in a recession, as investors avoid riskier bonds in search of more secure investments.

While bond yields aren’t back to the lows seen in the middle of last year, they are down from the highs experienced at the end of last year. In other words, the recessionary canary in the coal mine is quiet right now.

What it all means

Looking at the economy through an investor’s lens brings to two things to mind stocks and interest rates.

Faster economic growth has historically lent support to corporate profits, which provides a tailwind for stocks. It’s not a perfect relationship and we would expect we would get volatility along the way, but earnings growth and economic growth are key pillars for the stock market.

Second, the Fed is cautiously eyeing an acceleration in economic growth, as it hopes start hiking interest rates later in the year.

In a speech just before Memorial Day weekend, Fed Chief Yellen said she believes a 2015 rate hike is appropriate, but stressed that it all depends on the economic data.

A more rapid improvement in the economy could result in a faster pace of rate increases, while less favorable economic conditions could slow a series of rate hikes and/or delay the first rate increase.

She believes the latest economic slowdown is primarily the result of temporary factors. She specifically noted, “The U.S. economy seems well-positioned for continued growth.”

She is probably right, but we couldn’t help but take note of an interesting remark she made during her talk on the economy. “Based on many years of making economic projections, I can assure you that any specific projection I write down will turn out to be wrong, perhaps markedly so,” she said.

That’s transparency and candor taken to a new level. And it comes from the leader of the world’s most powerful central bank.

It’s just one more reason why we customize your financial plan and emphasize the longer-term. The odds of a recession this year are low, but it’s inevitable.

However, like the morning sun that follows the dark night, the economy has always turned higher. Patience is a virtue, as it has rewarded investors with a long-term perspective.

about the author: WorthPointe Wealth Management

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