The U.S. Economy
There continues to be mixed economic data coming out of the U.S. For example, while manufacturing survey data remain soft and the jobs report released at the beginning of May came in below consensus forecasts, retail sales have been relatively strong and the growth in new home sales has been stellar. The second estimate of growth in first quarter 2016 gross domestic product (GDP) was revised upward, but only to a 0.8% seasonally-adjusted annual rate (the initial estimate was 0.5%). The latest GDP release also included the first official estimate of U.S. corporate profits during the first quarter. Although they grew by 0.3% quarter-over-quarter—a reversal of the previous two quarters of negative growth—profits still decreased 5.8% year-over-year.
We continue to regard the sometimes-conflicting economic data as an indication that the economy will remain on its slow-growth trajectory. Nevertheless, while we don’t see any noteworthy catalysts on the horizon that would drive growth materially higher or lower, on balance the more recent data suggest the economy might be more likely to surprise to the downside than the upside.
In thinking about potential headwinds to the U.S. economy, the chart below shows that U.S. lenders have been tightening lending standards. Some firms in the energy sector certainly have had their access to credit curtailed, but the tightening could spill into sectors outside of energy and be a drag on U.S. investment.
Sticking with investment, the year-over-year growth rate of private sector capital expenditures has been steadily declining since the end of the third quarter 2014. This decline is connected to the rise in share buybacks during recent years, as a lack of attractive investment opportunities has led companies to use their cash to purchase their own stock. However, now that the general election campaign for president has started to coalesce, this decline also is one reason why there has been talk of fiscal stimulus in the next administration, regardless of who wins the election. The argument is that it would provide new momentum for the economy in the absence of capital spending by businesses.
New infrastructure investments are often highlighted as being an integral part of any stimulus package, as it is not a controversial position that the U.S. is in need of updated infrastructure. A much needed transportation bill passed by Congress last December and signed by President Obama provided some indication of the bipartisan recognition of the need for infrastructure upgrades. This is a topic to keep an eye on as the campaign unfolds.
Regarding the likelihood of the Federal Reserve raising the federal funds rate at its June meeting, the mixed economic data have also created a lack of clarity about whether the existing environment warrants a rate hike. The bond market has been signaling that the chances of another hike this year have increased, but there is evidence that monetary conditions have already tightened more than the hike of 25 basis points in December would imply, largely the result of a stronger U.S. dollar.
Global Economy
In Brazil, the Senate voted to hold an impeachment trial for President Dilma Rousseff, handing her another setback after she lost an impeachment vote in the lower house of Congress in April. Vice President Michel Temer has assumed the presidency for the duration of the trial, and would finish Rousseff’s term that runs through 2018 if the Senate convicts her.
From an investment perspective, Brazil beginning to move past Rousseff’s presidency is certainly a positive, if for no other reason than her main goal lately seemed to have been staying in power at all costs instead of governing the country and taking the hard steps needed to return foreign investor confidence to Brazil. If Temer’s administration is successful in uniting Congress behind an agenda that focuses on reforming the fiscal situation, making the economy more market-driven instead of interventionist, and tackling the stubborn corruption issues inherent in Brazilian politics, Brazilian assets could continue their recent successful run.
Absent these meaningful steps, however, we believe Brazil will remain vulnerable to just being a proxy for global commodity prices, as without the above fundamental reforms, the secular investment case would not change all that much.
In Japan, Prime Minister Shinzo Abe appears set to delay a sales tax hike planned for 2017 until 2019. Abe apparently has been concerned that the hike could make it harder to combat Japan’s problem of persistently low inflation. A previous sales tax hike, in April 2014, had a clear negative effect on growth.
