The week ended with a celebration of our independence and what better way to express independence then to have our free market environment cross a major threshold such as 17,000 points on the Dow Jones… This however will leave many investors wondering if the markets are overpriced and ripe for a correction. It is a crossroads, however the case exists for continued growth, although it may be at a more muted pace.
Gross domestic product (GDP) would ideally run at 3%, but as I discussed last week GDP has been running at an average rate of 2.1% throughout this expansion. This leaves room for further growth. When accounting for below expected inflation there is still 1.1% slack in the durable GDP rate expected for the US economy.
A major contributor to GDP growth is consumption. In order for consumption to thrive we need employment and income to grow. While income has been growing slower than long term averages (2.3% y/y in June vs a long term average of 4%[1]), employment has been picking up as of late. Unemployment has reached a current expansion low of 6.1% and non-farm payrolls increased by 288,000 in June[2]; marking the 5th straight month of over 200,000 jobs being added.
Interestingly, wages have not kept pace with the job additions, due in part to the under employment conditions in our country. While it is exciting that we are as low as 6.1% in unemployment it needs to be noted that those feeling they are under employed still sits at 12.1% (those working less hours, or out of the job market for a lack of prospects)[3].
Overall large company stock prices are at their long term appropriate valuations; however with the persisting low rate environment we have experienced valuations are actually slightly understated. If stock prices persist in this trend and grow at a rate similar to their earnings growth we would see growth, however slower growth than we have seen over the last several years. Looking at last quarter the growth rate for earnings, year over year, was 6.4%[4]. Earning growth in growth based organizations are likely to see a short term stagnation as they ramp up capital expenditures and hiring, while value based companies can maintain earnings through this transition.
What transition is being referred to? Tapering… Late this year tapering will come to a close and the crutch provided by the Federal Reserve will be completely removed and our free market will have to stand on its own two legs. This will come, undoubtedly, with increased volatility as the private sector learns how to walk and then (hopefully) run.
Internationally, PMI indicators in China reflect expansionary conditions, as well as those released for the Eurozone. Excitingly, the Eurozone Core Consumer Price Index (Core CPI) increased 0.1% year over year to 0.8%[5]. While 0.1% does not seem like much, it is meaningful. This is especially so for a region marred by recent concerns regarding deflation.
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Always remember that while this is a week in review, this does not trigger or relate to trading activity on your account with Financial Future Services. Broad diversification across several asset classes with a long term holding strategy is the best strategy in any market environment. Any and all third-party posts or responses to this blog do not reflect the views of the firm and have not been reviewed by the firm for completeness or accuracy.