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Kevin: Hello, John Finley, Kevin Coyle, May 2018 market update. Maybe start with a quick recap of how we've done year-to-date, John, and over the last year.
John: Year-to-date, we're about flat, but year-over-year, we're still up double digits, about 14% in the U.S. The market hit a new high on January 26th, but we're down about 6% from that.
Kevin: We've had a lot more volatility than usual. We were kind of lulled into a false sense of security maybe in 2017 with very, very little fluctuation and mostly up days, but this would be more normal.
Kevin: If you look back historically, we're going to have a lot more of these types of down days during the course of the year. The global backdrop, growth-wise, what does that look like?
John: It's still very supportive. We have global, synchronized growth. Maybe 70% of developed countries are in a pretty strong expansionary economic situation, which is good and low inflation. So it's a very supportive economic backdrop.
Kevin: So there are some fears out there, which we'll talk about in a second, but the correction that we had, maybe 6% down from the lows combined with increased earnings, part of that from the tax cuts, but from historical measures, the market would appear to be fairly valued at this point in time.
John: Right. The forward price earnings we're right about at the average, long-term average, and we're expecting earnings in the U.S. to be up about 20%, year-over-year, 25% on earnings per share basis, and the revenue top-line growth is still pretty healthy. It's 7%.
Kevin: So we talked about potential fears out there of inflation, which we'll talk about in a second. The other one, which has been since this recovery started, it's been a long but slow recovery. A lot of people think, "Well, it's nine years." It's what, the second longest expansion that it can't have legs much longer. It's got to be running out soon. What are your thoughts on that?
John: Well, this has been a different recovery coming out of the financial crisis than the other post-war recessions that we've had. We bounced back much quicker before, and we've just been plodding along at about 2% or so real GDP growth. And the reason for that is we've got the two components of GDP growth are population growth and productivity, and both of those are relatively low rates of growth right now.
Kevin: So if you look the numbers, the length of the expansion has been long, but the degree of the recovery has not been as significant.
John: Right. We’re seeing unemployment continue to drop, and that's creating some issues, maybe some labor shortages in certain industries.
Kevin: But we're not seeing that really show up in the inflation figures.
John: Not yet.
Kevin: So we're afraid about the length of the recovery, and we're afraid about inflation, but we're not really seeing signs.
Kevin: That those are rearing their heads this year.
John: Oil is up to $70 a barrel now, and lumber prices are up, so there are indicators that inflation may be on the rise. The Federal Reserve said recently that their inflation in the U.S. is approaching their 2%.
Kevin: Well so the Fed had been taking precautionary action, and they've been raising short-term rates, so you have that going on. You also have the Federal Reserve trying to unwind its balance sheet from the quantitative easing from the bonds they've purchased since the recovery. And then, you also have record deficits on the horizon, and this all adds up as potentially inflationary as well, correct?
John: Well, certainly, it's going to put pressure on interest rates as the Fed unwinds the balance sheet, and the government has to sell bonds to finance a trillion dollar deficit for the next five years. But the bond market is not really reacting yet to any higher inflation expectations. And, in fact, it may be a bit concerned the Fed will overshoot.
Kevin: So you have this balancing act going on, where you have potential inflation, but the bond market's saying that it's not seeing it, so rates have gone up, but the yield curve is still relatively flat. So the bond market's saying that it's seeking more potential of recession as opposed to inflation. But then you put that together with the global backdrop. The earnings and the economic climate is still positive, so it's kind of a different recipe of this Goldilocks scenario from couple years ago. It's all kind of mixing together, where it's kind of steady as you go kind of a scenario.
John: Right. Oh, yeah, it doesn't appear that, from what we can tell, the indicators that we watch, that there's a recession around the corner, certainly. And the backdrop, again, is very supportive from a global economic perspective.
Kevin: With all that being said, stick to your plan, but the volatility, I would imagine, will continue to be present because there is some uncertainty as to some of these issues that are out there. So those are the things we'll be looking for going forward. Until our next update, enjoy.
Posted on Tue, May 15, 2018
by Jess Poisl filed under