THE SPRING LETTER
Art and poetry are more necessary to human beings than bread. They prepare them for the life of the spirit”
– Jacques Maritain, Reponse a Jean Cocteau
Economic Perspective
The huge cut in the US corporate tax rate has borrowed growth from future quarters. US economic growth is likely to approach Trump’s forecast of 3% this year but taper off in subsequent years. The other principal engine of global growth, China, continues to massage reported GDP growth figures, creating doubts about their accuracy.
The US economy encountered twin challenges in the latest quarter: rising oil prices and a weaker US dollar. Erratic winter weather compounded the challenges. Accordingly, factory orders declined for several successive months. The job market tightened; the unemployment rate stable at 4.1%. Nevertheless, wage inflation remained anemic (until March) as did retail price inflation. Rising wages and companies’ failure to invest in capital goods caused labor productivity to slip in the first quarter. Industrial production growth continues fair.
Global spikes in political risk, e.g. North Korea and Syria (and trade tension with China), drove the rise in gold prices. Oil prices remained firm as the crash in Venezuelan production more than offset the shale oil boom in the US.
Further bolstering domestic economic growth is a revival in the housing market and improving consumer sentiment. Though interest rates remain historically low, the Federal Reserve, under new Chair Jay Powell, is set on a path of gradual rate increases to keep on pace, or ahead, of inflation’s rise. The economic recovery remains robust but fragile.
In reaching for growth, corporate America increasingly relies on acquisitions and share buybacks (essentially forms of financial engineering) rather than capital investment and organic growth. Too little of the corporate tax windfall is being directed to capital investment, now at its lowest level as a percentage of GDP in years.
Market Thoughts
The US stock market took its cue from the latest Twitter storm out of Washington. Investors feel the pain of losses more intensely than the pleasure of gains. Volatility returned to the stock market with a vengance this past quarter though trading volumes are often very subdued.
The year opened with an upward spike in stock prices until late January. Investors remain skittish; one erratic political development (for example, threats of a trade war with China) and the stock market drops abruptly. In general, stocks remain fairly priced, but high growth technology stock prices have temporarily galloped ahead of their business prospects. At mid-February the FAANG stocks accounted for 15% of the S&P’s market value, a level of technology concentration not seen since the bursting of the tech bubble at the dawn of the millennium.
In an effort to navigate the challenging equity markets, we emphasize sectors like: consumer staples (Ingredion, Nestle); manufacturers (ITW, Parker-Hannifin, Wabtec); medical equipment makers and pharmaceuticals (Bristol Myers, Johnson & Johnson, Pfizer); entertainment (Comcast, Disney, Liberty Global); selected technology (nVidia, Xylem); insurance (Alleghany, White Mountains); and, dividend plays like Kinder Morgan and ONEOK Inc. (energy pipelines).
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Stephen K. Bache, CFA
Sources: Bloomberg Businessweek, The Economist, New York Times, The Wall Street Journal, Alan Burdick, Why Time Flies; James C. Scott, Against the Grain
