Friday, August 11, 2017
The stock market extended record highs in the second quarter mostly on the back of
information technology stocks that have rallied by more than 17% this year. While some
valuation measures of equities appear stretched, an acceleration in company earnings and
revenue growth, low inflation and low interest rates are providing impetus for further gains in
the stock market. Meanwhile, the bond market continues to surprise. After a yield surge in
late 2016 and a 0.25% increase in the Fed funds rate, long term bonds have rallied as
witnessed by the near-4% gain through the end of June! Even foreign markets came back to
life with the MSCI World ex U.S. Index rising nearly 11%.
The Economy
First quarter GDP rose a weak 1.4% falling well below the 3% potential growth that
economists tell us is a reasonable expectation based on historical analysis. Our current
economic growth of less than 2% is one of the slowest growth expansions on record. From
our perspective, the culprits are the absence of favorable fiscal policy and the burden of overregulation.
Even though stock markets have risen to record levels both in the U.S. and abroad,
we still have not seen any traditional stimulus efforts coming out of Washington. However,
steps to reduce regulation across the economy may be having the intended effect of lowering
the costs of being in business. Both consumer and business confidence have risen to record
levels -- an important contributor to future economic activity. Slow economic growth is
favorable as we are not experiencing demand pressures that will elevate traditional measures
of inflation. On the other hand, slow growth inhibits rising standards of living and limits the
ability of the federal government to pay its bills through rising tax revenues.
The most important factor in keeping our economy growing has been the low and stabilizing
oil price -- somewhere between $45 and $55 a barrel. As lower oil prices work their way
through the economy, there is downward pressure on prices across the economy as companies
incorporate lower energy costs into intermediate and final goods prices. As output from the
U.S. increases, the revenues generated by those sales stay in the U.S. rather than being
shipped off to OPEC nations. On one hand, the decline in oil prices has been great for
consumers and should continue to put downward pressure on inflation. On the other hand,
those lower prices penalize our domestic producers that must dance to the tune of OPEC's
efforts to put them out of business by driving oil prices down. If oil prices soar above that $55
level, then there will be a surge in U.S. production or if oil collapses below the $45 level then
domestic production will shrink accordingly. These supply forces will tend to keep oil prices
in a general equilibrium.
On balance, we expect to see improving economic growth for the second quarter but little if
any improvement above a 2% real growth rate for the balance of 2017 unless we get tax rate
reductions or federal spending increases.
The domestic economy is improving slowly and would grow a great deal faster if the current
administration could push through tax-rate reductions and decreased government regulation.
The private sector is improving due to rising consumer and business confidence. The prospect
of reasonable oil price stability and a less volatile dollar should add to business certainty and
improving output. If profit forecasts hold up through year-end we expect to see a continued
rise in equity prices while interest rates remain essentially flat.
Diane V. Nugent, President/CEO
Thomas E. Nugent, Executive Vice-President