On my occasional trips to Dublin, I often fit in a game of tennis with my brother Nick. This is a ritual exercise in humility and humiliation, since Nick is skilled at tennis and the score is always lopsided in his favor. However, in my defense, I must mention that I am always handicapped by local conditions. I never bring a tennis racquet across the Atlantic so I must play with one of his. To make things worse, we play on grass, invariably after it has just rained or with a soft drizzle enveloping us. Nick supplies the tennis balls also, which he says are “all-weather”, a concept which I still find foreign to the game of tennis, (which ought not be played in all types of weather). And the problem is, these tennis balls don’t bounce, or at least not the way that I am used to.
This, right off the bat, disrupts my already erratic timing and I am forced to approach the ball in a very orthodox and deliberate way. All ambitions to add slice or topspin are abandoned in lunging attempts just to make contact with the sodden object. Managing to loft it over the net at all, counts as a major achievement. It is not so easy playing with a ball that won’t bounce.
And it is not so easy investing in an economy that won’t bounce either.
Despite a surge in consumer and business confidence in the wake of the election, real GDP growth slowed to just 1.2% annualized in the first quarter. While this number is depressing, it appeared to be just the return of the first-quarter curse which saw very weak growth in the first quarter of 2016 and actual declines in output in the first quarters of 2011 and 2014. Of course, if the weakness was just related to seasonal adjustment problems, a bounce-back to stronger growth seemed on the cards for 2Q2017.
However, as the data have begun to roll in for the second quarter, this assumption is looking a good deal more shaky.
· Light-Vehicle Sales, which averaged 18.0 million units in the fourth quarter and 17.2 million units in the first, fell to 16.8 million units in April and look set to only match that pace when May data are released this Thursday.
· Housing starts were at a 1.25 million unit pace in the fourth quarter, a 1.24 million pace in the first quarter and fell back to a 1.17 million unit pace in April. Moreover, this week’s data on Pending Home Sales should mirror the decline registered for April in both new and existing home sales.
· We estimate that real capital goods shipments were up in April relative to their first-quarter average but only just.
· Both retail and wholesale inventories fell in April and it now appears that real inventory growth could be flat to negative for the second quarter.
· International Trade also appears to have gotten off to slow start in the second quarter with the goods deficit in April exceeding its first quarter average. Numbers due out on Friday should confirm that this is also the case when services are included.
· Finally, the Personal Consumption Deflators for April, due out on Tuesday, could show the weakest year-over-year core inflation since December 2015. While part of the reason for this is a big one-time decline in cell-phone charges, the reality is that core inflation remains very subdued.
It should be emphasized that the week ahead will likely also contain some reassuring economic news. Both the Markit and ISM Manufacturing PMI numbers should show some improvement in May over April. In addition, while the economy may only have added a moderate 150,000-175,000 payroll jobs in May, this could be enough to cut the unemployment rate further to 4.3% in Friday’s Employment Report.
However, even conceding this, it now appears that second quarter real economic growth could come in at between 1% and 2% annualized, showing no meaningful bounce-back in momentum from the first.
What are investors to make of this? Three points:
First, a failure to bounce is probably not a harbinger of recession. Weak second- quarter numbers make third-quarter comps that much easier. A fall in inventories, in particular, should it transpire, cannot be sustained and getting back to a normal pace of accumulation would likely boost growth in upcoming quarters. More importantly, there is, so far, no particular shock or area of economic boom turning to bust that could unleash the vortex of negativity that is at the center of any actual recession. Still, a slow-growing economy is more vulnerable to recession, increasing the importance of buying based on valuations and diversifying across asset classes and around the world.
Second, weaker economic growth, particularly if accompanied by softer inflation, could reduce bond-market risks. In recent meetings and speeches, the Fed has noted their expectation for a total of three rate hikes this year, with one already having occurred in March. Since March, the messaging from the Fed seemed to setting up expectations of another hike in June. However, if weak data convince the Fed to skip a rate hike at their June meeting, many will wonder if they should expect any further rate hikes at all this year. A once-again more reluctant Fed could suppress the long-awaited pickup in long-term bond yields.
Third, a slower U.S. economy demands a more careful approach to U.S. stocks. On Friday, the S&P500 closed at a record high level of 2,416, and is trading above 17.5 times analysts’ rather rosy earnings projections for the next twelve months. Of course stronger economic growth and corporate tax cuts could make those projections seem more reasonable. However, without continued strong earnings gains, overall valuations look high. This does not imply underweighting U.S. stocks – very low yields on U.S. cash and bonds still make stocks look attractive relative to other domestic assets.
However, it does suggest a more cautious approach, highlighting the importance of investing in stocks and strategies focused on cheaper valuations in an America where for now, growth refuses to bounce.
David Kelly is chief global strategist at JPMorgan Funds.