What’s Up On Wall Street – Fall 2018

Stock markets were generally higher over the waning months of summer, with stocks of large US companies for the quarter up by 7.7%, small U.S. companies up 3.6%, and foreign stocks up 1.4%. Bonds, broadly measured, were flat for the quarter, though down 1.6% so far this year.

Trade tensions have remained front and center in economic news as the administration has continued to press for additional tariffs, as announced during the quarter. However, vigorous growth of the U.S. economy, fueled by tax cuts, has served to allay trade war concerns among investors for now. Third quarter  profitability at large U.S. companies is projected to grow by a noteworthy 19% over the same period a year ago. Corporate profitability is considered a primary driver of stock market valuations.

While economic growth has supported stocks this year, bond prices have stumbled. In a counterintuitive twist, upbeat economic reports can be unwelcome news for bond investments. This is because a fast-growing economy may invite further interest rate increases from the Fed to slow the pace of growth, and economic growth is normally inflationary. Both of these conditions—rising rates and the threat of inflation— have decreased bond values over the year. While Natural Investments selects a range of sustainable bond investments intended to mitigate the full burden of these influences, a roaring economy still creates pressure for most bonds.

Speaking of a roaring economy, how much roaring is too much? For most of the decade since the Great Recession, U.S. economic growth has run at an annual pace of about 2%, give or take. The long-term growth rate in the U.S. has been about 3.25%, though this has been accompanied by frequent and often painful boom and bust cycles. The (annualized growth rate for second quarter was 4.2%— nearly a third higher than the long-term average. This is a substantial deviation from the historic average and may be an advance warning of an overheating U.S. economy. The chief risk of this feverishness would be a sudden and steep leap in inflation, which would require an extraordinary Fed response (most likely a significant, rapid rise in interest rates).

The last two recessions were brought on by the bursting of market bubbles: first the dot-com stock market bubble in the early 2000s, then the housing bubble starting in 2006. However, these two recessions were exceptions to the rule since the end of the Second World War. To cool growing economies, the Fed itself has triggered many of the post-war recessions by interest rate increases that proved too weighty for economies to withstand. Accelerating Fed interest rate hikes could be the consequence of excessive growth and could ultimately usher in a U.S. recession.

Trump-era tax cuts have been primarily credited with spurring recent economic activity, although at great cost. According to the Washington Post, when Trump was running for president, he once promised to eliminate the national debt within 8 years. But projected deficits have exploded on his watch. The U.S. annual budget deficit is projected to grow by 18% in 2019 and will hit $1 trillion by 2020, according to the Congressional Budget Office. With a hefty tax-cut in hand, those who have howled for fiscal responsibility in the past have been silent.

The administration has issued budgetary objectives for 2019, including double-digit spending cuts to the Environmental Protection Agency, the Labor Department, the State Department, Medicaid, SNAP (food stamps), and Section 8 housing. The plan would eliminate student loan forgiveness for those going into public service and add $700 billion to defense spending over 10 years.

Perhaps this is the cost of “greatness.” Given our apparent national priorities, the prescient “It’s the economy, stupid” quotation from then-presidential candidate Bill Clinton in 1992 seems to remain a truism. Much can be ignored when the economy grows. Mahatma Gandhi’s famous contrasting view, “A nation’s greatness is measured by how it treats its weakest members” is certainly worth reflection in today’s environment.

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