Download Falling Short of Expectations - Legacy Private Trust Company

Volume 11, May 2016
Falling Short of Expectations
Here we go again. Like a scene from “Groundhog Day”,
economists once again fell into the trap of hoping things
would be different in the first quarter. But as was the case
in both 2014 and 2015, we once again woke up to an eerily
familiar pattern – an economy that is stumbling out of the
starting gate. To make matters worse, forecasters – both
in the private and policy-making sectors – were convinced
until recently that growth would stage a solid rebound
from the tepid showing in the fourth quarter of last year.
Indeed, last December Federal Reserve officials thought
conditions would be strong enough to justify four interestrate increases this year.
Things are not turning out that way, at least for now. The
advance estimate released by the Bureau of Economic
Analysis in late April reports that real GDP expanded at
a mere .05 percent annual rate in the first quarter, even
weaker than the already-tepid 1.4 percent pace of the
2015 fourth quarter. That would be the weakest twoquarter reading in three years and offers little hope that
the economy will break out of the subpar growth rate that
has characterized the nearly seven-year old recovery from
the Great Recession. Keeping to the script, the Federal
Reserve dialed down its expectations and now plans to
raise rates only twice before year-end. Private forecasters
and financial markets are even more skeptical, placing
even odds that only one hike will be forthcoming.
Some statisticians wonder if there is a disturbing bias
in the first-quarter data that makes the economy seem
weaker than it actually is. But when things don’t change
year in and year out, quarterly quirks don’t seem to
matter. Call it the new normal or, as the International
Monetary Fund (IMF) Chief Christine Lagarde prefers,
the new mediocre. Speaking of the IMF, its revised World
Economic Outlook released in April is also painting a
gloomier picture for the global economy, lowering global
growth estimates this year to 3.2 percent from 3.4 percent
projected in January. Ironically, the IMF singles out the
U.S. as a relatively bright spot in the larger scheme of
things, noting that less restrictive fiscal policies, healthy
balance sheets and a steadily improving housing market
will sustain growth at about last year’s pace of 2.4
percent. Spain’s projected 2.6 percent is the only advanced
economy expected to be stronger, but it reflects a decline
from the 3.2 percent growth rate in 2015. So if nothing
else, give credit to the U.S. for being the best house in a
deteriorating neighborhood.
First-Quarter Growth: Weak but Resilient
Like the IMF world outlook, the Federal Reserve also cut
its growth forecast for the U.S. at its March policy meeting,
revising it down to 2.2 percent for 2016 from 2.4 percent
projected last December. But even that lowered growth
forecast will be hard to meet as it was made before the Fed
knew how sickly the first quarter would turn out to be.
By all accounts, the final
The vast majority of
month of the period was
much weaker than expected,
economists believe the
reflecting surprisingly soft
odds of a recession this
retail sales and production.
year are very small.
To meet the Fed’s growth
...most believe the
forecast for the year, activity
first-quarter slowdown
would have to accelerate
strongly over the next three
overstates the economy’s
quarters, something that’s
fundamental weakness.
hardly a sure thing.
That said, the skeptical statisticians may be on to
something. In five of the past six years, the first quarter
has been significantly weaker than the rest of the year, a
recurring pattern that raises questions about the accuracy
of seasonal adjustments. Some feel that the outsized
contraction in output during the Great Recession may
have messed up computations of seasonal patterns, albeit
the jury of experts is still out on this issue. Still, the Great
Recession ended nearly seven years ago, and the ups and
downs since then have not lifted the overall growth rate
much beyond the lackluster 2 percent or so. If the economy
were growing faster – say close to the 4 percent-plus typical
of past expansions – a recurring slowdown in a particularly
quarter would not be worrisome. However, with growth
hovering near stall speed for the last two quarters,
economists understandably worry that a sudden shock can
knock the recovery off the rails.
Continued next page
Persistently Weak First Quarter
GDP Growth Rate
4.0
Rest of Year (Average Growth Rate)
3.0
2.0
1.0
0.0
First Quarter
-1.0
-2.0
2010
2011
2012
2013
2014
2015
Falling Short of Expectations
Continued from front page
However, the vast majority of economists believe the odds
of a recession this year are very small. That appears to be
an indication that most believe the first-quarter slowdown
overstates the economy’s fundamental weakness. Like the
corresponding first quarters before it, the latest setback is
widely perceived to be a temporary soft patch that opens
the door for another revival in the spring and summer
months. Indeed, considering the headwinds buffeting
the economy during the quarter – the lagged effects of
the strong dollar, extreme turbulence in the financial
markets, weak foreign demand and uncertainty created by
geopolitical turmoil surrounding repeated terrorist attacks
– even the tepid advance can arguably be viewed as more a
sign of resilience that weakness.
Consumers Pulling Back
The uncertainty is whether the economy can recover from
its recent malaise and deliver a respectable performance
over the rest of the year, much as was the case in 2015. By
respectable, of course, we are talking about a growth rate
within the upper level of the 2.0 – 2.5 percent range seen
since the end of the Great Recession – not the 3.0 to 4.0
percent typical of previous upturns. Despite the slow start,
last year’s 2.4 percent increase in real GDP was just a tad
under the strongest annual gain of the recovery so far – the
2.5 percent increase in 2010.
Keep in mind that last year’s growth was powered mainly
by consumers. The 3.1 percent increase in real personal
consumption was the strongest annual gain in ten years,
far exceeding the 2.0 percent average growth rate over
the previous five years. A key contribution came from
higher expenditures on health care, which largely reflects
the increase in households enrolled in Obamacare. Also,
Americans resumed their love affair with cars, the biggest
discretionary purchase outside of a home. In 2015, sales of
autos and SUVs soared to 17.33 million, the most in fifteen
years.
But those two key drivers may not be as influential this
year. The growth in health care spending is already starting
to wane, as the biggest growth spurt in enrollment under
the Affordable Care Act (Obamacare) is behind us and
medical care costs are slowing. Meanwhile, the ardor for
autos is starting to cool. After hitting a peak annual rate
of 18.1 million last October, sales of autos and SUVs have
Continued next page
Legacy’s Core Equity Portfolio
Legacy’s Global Tactical Growth Portfolio
The Core Equity Portfolio is designed to ensure broad
participation in the equity market, with less than average market
volatility, while effectively producing a meaningful performance
edge for our clients. Our active valuation strategy and analysis
focuses on individual stock selection in conjunction with
economic sector discipline that looks beyond mainstream
consensus to construct customized client portfolios.
The The Global Tactical Growth (GTG) Portfolio is a disciplined,
proprietary investment solution designed to maximize long-term
investment returns with moderate risk. Legacy’s goal is to position
the GTG portfolio in the best performing asset classes (domestic
equity, fixed income, foreign equity, foreign and domestic real
estate, commodities and currencies) using all Exchange Traded
Products.
The graphic below shows the sector weightings in the Core
Portfolio as of April 2016.
The chart below shows the GTG asset allocation mix across the
four major asset classes over the past six months.
Global Tactical Growth Portfolio Composition
Core Equity Portfolio Composition
Financials
16%
Energy
100
4% Utilities
4%
80
Information
Technology
16%
60
Industrials
16%
40
20
Health Care
16%
Materials
4%
Consumer
0
Discretionary
16%
Consumer Staples
8%
100%
100
80%
80
60%
60
40%
40
20%
20
0%
0
Nov ’15
Dec ’15
Jan ’16
Feb ’16
Mar ’16
Apr ’16
Domestic Equity
Foreign Equity
Fixed Income
Alternatives (Real Estate, Commodities, Foreign Currency)
Past performance does not predict future results. Current and future results may be lower or higher than those referenced in this newsletter. Investments are not FDICinsured, nor are they deposits of or guaranteed by a bank or any other entity. Investment return and principal value will fluctuate and investments may lose value.
Falling Short of Expectations
Continued from previous page
since fallen erratically, hitting 16.5 million in March. The
slowdown in auto sales, both in numbers and dollars
spent, contributed importantly to the retail sales slump
that month.
Vital Housing Support
If, as seems likely, consumers will be less of a driving force
this year, the economy’s growth engine will need to draw
fuel from elsewhere to match last year’s performance.
The prospects are few, but there is at least one promising
candidate. Homebuilding activity, which made a significant
contribution to growth last year, should continue to provide
meaningful support going forward. Housing starts increased
by 10.5 percent in 2015 and are up 14.5 percent in the first
quarter from a year ago.
Importantly, the biggest gains are now coming from singlefamily as opposed to multifamily construction, which had
previously been the biggest driver of the housing recovery.
This is important for two reasons. First, single family
construction delivers a bigger bang for the buck in terms of
overall GDP growth, as an individual home requires more
resources – labor, building materials and supplies – than an
apartment unit. Adding up these resources translates into a
construction value of $323 thousand for an average single
family home compared to $128 thousand for a multifamily
rental apartment, according to the National Association of
Home Builders.
Second, construction of a single family home generates
2.97 full-time jobs, nearly three times as many per unit as
a multifamily building. This is already energizing the labor
market. Over the past six months, the increase in housing
starts has generated 200 thousand construction jobs, the
largest total for a similar span since 2006 that turned out
to be the tail-end of the housing boom. The good news is
that single-family construction should lead the housing
recovery going forward, reflecting the ongoing strength in
the job market that is boosting incomes and spurring more
household formations.
Crosscurrents Will Keep Growth in Check
On balance, housing should provide moderately stronger
support for the economy this year than in 2015. Some
additional help is expected from the public sector, as state
and local governments are loosening their purse strings
even as Washington moves further away from fiscal
austerity, reflecting a projected widening of the budget
deficit this year. However, the business sector is still not
stepping up to the plate. Corporations are retaining a tightfisted attitude towards expanding capacity or investing in
productivity-enhancing equipment that crimped growth late
last year and the first quarter of this year.
One daunting headwind is the weak global economy, which
together with the dollar’s climb from mid-2014 to late last
year clobbered exports and manufacturing activity last
year. That drag has carried over into this year as exports
continued to slump through the first quarter. However, the
drag from trade may soon ease, as the dollar has stabilized
and even weakened a bit against major currencies in recent
months. That said, the greenback’s pullback is a mixed
blessing because it largely reflects perceptions that the U.S.
economy will be too weak to justify as many rate hikes as
the Federal Reserve had planned to put into effect late last
year.
Putting it all together, the economy’s growth engine is still
not firing on all cylinders, dampening hopes that it will
shift into a much higher gear this year. One wild card is the
election. Ordinarily, the economy tends to fare better in
the fourth year of a presidential cycle, growing faster than
the third year in 10 out of the last 14 elections. In the four
times it hasn’t, the economy was in a recession. Barring a
sudden shock, it’s unlikely that a downturn is in the cards
for the U.S. this year. However, the escalating rancor being
expressed during the current campaign and the increasing
acceptance of candidates espousing some revolutionary
ideas for the economy could well heighten uncertainty over
future policies. That’s something economists can’t put into
their crystal ball. n
Growth Boost in Presidential Election Years
Pecent Change from Previous Year in Real GDP
6.0
4.0
2.0
0.0
-2.0
-4.0
-6.0
60
64 68
72 76 80
84 88
92 96 00
04 08 12
To learn more about Legacy and our services, call 920.967.5020.
Two Neenah Center | Suite 501 | Neenah, WI 54956 | 920-967-5020 | www.lptrust.com
© 2016 Legacy Private Trust Company. All rights reserved.