The expansion appears to be facing several headwinds as we enter the second half of the year. Growth has been slower than expected, expectations for fiscal stimulus have waned, and policy progress has been priced out of the bond market. Consumer and business credit growth have generally declined. Inflation has receded and productivity growth continues to be subpar. Yet against this subdued economic backdrop we see clear signs of economic resilience and strength that provide a balanced picture of a still-moderately growing economy:
- The environment for risk assets continues to be favorable. Credit fundamentals remain stable, volatility has been low, and risk assets are benefiting from the ongoing search for yield. Equities have been buoyed by low interest rates, low inflation, good earnings growth, and high optimism. A disappointment in reported earnings could trigger a 5%–10% retreat in prices, but we would likely consider such an event a buying opportunity.
- Other indicators signaling economic health include elevated consumer confidence, an upward-sloping yield curve, and advances in the US Leading Economic Index (LEI).
- Traditional signs of recession are generally absent, along with signs of potential systemic risk such as excessive leverage or inflation and supply/demand imbalances.
- Consumer spending is expected to be moderate, and business spending should pick up once uncertainties surrounding regulatory reforms dissipate.
- Outside the US, the world economy continues to expand, though geopolitical risks remain elevated and are at the forefront of our concerns.
First-quarter growth is known to be seasonally weak; historically, GDP growth increases during the second half of the year relative to the first half. Still, economic growth is unlikely to meaningfully exceed 2.0% for 2017 without significant fiscal stimulus. Yet absent such stimulus, the recent weakness in economic data is likely to be a temporary lull.
Subpar productivity and labor force growth will keep GDP from returning to the robust levels seen in prior decades, but the economy is stable and on track for continued moderate expansion. It is this slow, steady, trend-like growth that has enabled the economy to continue expanding. In this environment, an overweight in fundamentally sound risk assets and an underweight in interest rate sensitivity should be rewarded over the course of the year. Overall, our expectations for a little more growth, a little more inflation, and a little more Fed have not changed since the beginning of the year.