Stocks finished a seesaw week to the downside on Friday in a rather listless session. With earnings season winding down, we are entering a period mid-quarter where we can expect a dearth of new economic or corporate news. What news does become available, therefore, can take on outsized meaning. With trade issues dominating the front page, any movement for better or worse will clearly have an impact. The same can be said for any economic data signaling a change in trend.
Recent data, including real time survey data we see, appears to be showing a modest deceleration in the economy. The accent is on the word modest. Nothing we see points to any sudden change. Near term fluctuations can be caused by weather, season trade factors, or inventory liquidation. Nothing moves in exactly a straight line and that is particularly true for economic data. In addition, over short intervals, government data can be very volatile and subject to significant subsequent adjustments. But with all that said we note the following:
- Q1 growth of 3.2% was weaker than the top line number indicates given the strong improvement in trade (almost certainly temporary) and buildup of inventories. Those inventories will be liquidated in the following months. Already, economists are suggesting growth closer to 2% in the second quarter.
- The U.S. birth rate has declined to its lowest level in decades. While there has been a lot of political conversation surrounding immigration, data shows it to be roughly consistent with prior years. Demographics tell us that the number of baby boomers retiring in the next few years could be larger than the increase in 16-21 year olds entering the working class. Thus, at best, demographics are a neutral to negative influence on growth.
- As an offset, productivity has shown steady improvement over the past year and was over 3% in Q1. But that may not be sustained given a significant slowdown in investment spending in Q1. And that was during a period where optimism for a near term trade agreement with China was high. Now that no one really knows the rules of engagement relative to trade over the next year or more, expect capex to stay below levels needed to produce accelerated gains in productivity.
- The dollar has stayed stable, suggesting that the forex negative impact on earnings peaked in the first quarter and could be negligible during the second half of the year.
- While Treasury bond yields have fallen over recent weeks, yield spreads have widened, a statement by the bond market that risks are rising.
The bottom line is that growth is slowing slightly, inflation remains in check, but uncertainties are also rising. On balance, this should work out to be a slight negative for stocks. As we enter the summer months, trading could get light but volatility could also increase. Should volatility rise sharply, that would be a setup for a larger correction than markets suggest at the present time. That was stated as a big if, not a prediction. Based on earnings and interest rates, stocks are close to fair value, suggesting a violent move in either direction isn’t to be expected.
In a flat to modestly down market, what should investors do? First, there is no reason to change either asset allocation or long term positions. Second, valuation always matters. Extended stock positions can be trimmed. Bargains always provide opportunities. In a dull market, I look for companies that:
- Grow meaningfully faster than overall GDP.
- Have growing free cash flow, and
- Are fairly valued relative to their own history and growth rates.
I would overlay two other factors:
- I want to limit exposure to companies that either face accelerating political headwinds or
- Face a deceleration in growth.
In the first category, that would include companies exposed to China or to pressures on drug pricing.
One can argue that these one-time pressures create opportunities. That’s true, but not until pressures start to wane. I don’t see that happening any time soon.
Today, Rachel Platten is 38. Race car driver Tony Stewart is 48.
James M. Meyer, CFA 610-260-2220