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The Economy and the Markets | Third quarter 2018

Economy forging ahead in face of higher rates

The third quarter is looking like it’s going to register another strong performance, pushing the second quarter’s already strong pace. Among the quarter’s highlights:

  • Rock-bottom unemployment
    • The jobless rate fell from 3.9 to 3.7 percent in September. December 1969 was the last time unemployment was lower.¹
  • Rising stock market
    • The Standard & Poor’s 500 Index was up 8.99 percent for the year and 7.2 percent for the third quarter — the market’s best quarter performance since 2013, according to one measure.²
  • Consumer confidence also rose, reaching its second highest level since 2004.³

Markets are currently pricing in another rate hike in December, and at least one more in 2019.

Job seekers to job openings ratio falls below 1.0

Graph: Job seekers to job openings ratio falls below 1.0

Source: Bloomberg. Unemployment and Job Openings, December 2000 - September 2018

Growth in average hourly earnings for the last 12 months slipped from 2.9 percent in August to 2.8 percent in September. But wage growth outpaced price increases, with inflation up 2.7 percent for the same period.⁴

The nation’s second longest expansion continued full speed ahead, despite the Federal Reserve (Fed) increasing interest rates and the despite Trump administration tariffs. We expect this expansion will go down as the longest uninterrupted growth streak in U.S. history. 

Fed remains in tightening mode

At its September meeting, the Fed raised rates for the third time in 2018, reflecting confidence in the economy’s strength. Markets are currently pricing in another hike in December and at least one more in 2019. Financial conditions remain favorable, and even with higher interest rates, business and consumer borrowing grew.

Strong employment, economic growth, rising deficits and the end of Quantitative Easing (QE) are reasons for longer rates to firm. So far, the 10-year Treasury has increased moderately and indicates the markets believe the Fed’s policies are likely to keep inflation under control and the economy from overheating.

Investors are looking for signs that the Fed has gone too far. Demand for long-term investments at yields lower than short-term rates indicates buyers are expecting the economy to slow. This difference has narrowed over the last several years, but the relationship remains positive for now. All signs point toward continued growth.

Businesses confidence soars

Consumer confidence has risen, but small business confidence has soared.

  • The September Small Business Optimism Index put small business enthusiasm at an all-time high.⁵
  • Commercial real estate is strong in all sectors and manufacturing is on the rise.
  • Consumer confidence is still on an upward trajectory and remains near multi-year highs.

Businesses, however, are having a hard time finding workers.

Small business confidence reached record high

Graph: Small business confidence reached record high

Source: Bloomberg. Small Business Optimism Index, September 1998 - September 2018

Businesses, however, are having a hard time finding workers. The economy has produced more jobs than job seekers. The quit rate also reached a 17-year high.⁶ Employees now have the confidence to leave their current jobs to find ones with better pay or working conditions.

Trade negotiations and tariffs pose another potential challenge. Tariffs could lower business confidence and slow spending on plants and equipment. But in a U.S. economy of approximately $17 trillion, $250 billion in tariffs aren’t going to have a major impact.

The Tax Foundation estimates that the announced tariffs (including those enacted in mid-September) will reduce Gross Domestic Product by 0.12 percent, cut wages by 0.08 percent and eliminate 94,303 full-time jobs.⁷

With progress on a replacement for NAFTA, focus is shifting to Europe and, later China. Businesses are encouraged by the draft agreement in North America, which is not expected to dramatically disrupt supply chains.

We see tariffs and trade issues as an economic pothole, unlikely to push the economy off its positive track in the near term.

Soft spots: Housing, corporate debt

Even in this bright and shining economy, a few dull spots remain. Residential investment, normally a strong economic driver at this point in the cycle, continues to disappoint.

  • Sales of new and existing homes have lagged.
  • Mortgage activity has dropped off.
  • The housing affordability index from the National Association of Realtors has reached 2004 levels.

Housing is no longer the deal it was in the years after the financial crisis. The debate continues as to why housing is lagging. Low supply, a shift towards renting and aging in place are all headwinds. However, there’s no question that higher home prices and mortgage rates are a burden, particularly for younger buyers with student loan debt and low disposable income.

While the lackluster housing market is a drag on economic growth, we don’t think housing prices are in a bubble. Rather, on the fixed income side we see the housing sector as an opportunity. Consumer credit is generally strong. Foreclosures are way down. With a limited supply of homes, homeowner equity is in good shape. Consumer borrowing is up, but has plateaued at a level within people’s means.

As a result, we’ve been shifting our exposure more toward the consumer-facing sector in our core fixed income strategy, including the structured residential market and asset- backed securities. 

The outlook: Staying strong

“Cycles don’t die, something kills them,” is a familiar market saying. We agree, and expect the economy to remain strong over the next 12 months.

The New York Federal Reserve puts the chance of a recession 12 months ahead at  less than 10 percent.⁸ A Federal Reserve of Atlanta Index finds that businesses expect inflation in the year ahead to be 2.2 percent, a level that doesn’t make markets nervous.⁹

What could end our economic expansion? An overly aggressive Federal Reserve is one possibility. Corporate debt is another. The end of QE on the global level will likely become a headwind. Or an unanticipated economic threat could emerge.

Also, the market appears to have priced in a Democratic takeover of the U.S. House of Representatives. If that happens, we will likely return to gridlock reminiscent of the Obama administration.

Regardless, we are optimistic and expect to reach the third quarter of 2019 in the midst of the longest economic growth streak in our country’s history.

1. “Job creation, wages chill out in September but unemployment falls to 48-year low,” Jeffry Bartash, MarketWatch, October 5, 2018.

2. “Stocks End Little Changed on Last Trading Day of Third Quarter,” Jessica Menton and Riva Gold, The Wall Street Journal, September 28, 2018, .

3. “Index of sentiment for current and future economic conditions,” University of Michigan, Surveys of Consumers, September 2018.

4. U.S. Department of Labor, Bureau of Labor Statistics, Economic News Release, September 2018.

5. “Small Business Optimism Shatters Record Previously Set 35 Years Ago,” National Federation of Independent Businesses (NFIB), September 11, 2018.

6. U.S. Department of Labor, Bureau of Labor Statistics, July 2018, “Number of Americans who quit a job, monthly.

7. “Impact of Trump Administration Enacted Tariffs,” The Tax Foundation, September 2018.

8. “Probability of a Recession,” Federal Reserve Bank of New York, September 2018.

9. “Business Expectations of Inflation,” Federal Reserve Bank of Atlanta, September 2018.

Source is Bloomberg for all information, unless noted otherwise.

Investments will fluctuate and when redeemed may be worth more or less than originally invested. Past performance is not indicative of future results. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision.

This commentary should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy. Opinions expressed herein are those of  Securian  Asset Management, Inc., only. Investors should keep in mind that markets are volatile and unpredictable. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested.

This article contains forward-looking statements based on expectations and assumptions. Actual results could differ materially because of changes to these expectations and assumptions. The Economy  and  the  Markets has been prepared for informational purposes only and is the opinion of Securian Asset Management, Inc., a registered investment advisor.

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