The U.S. economy grew at an approximate annualized rate of 2.6% - 2.9% in 2017. Real GDP in the 34 quarters since the recession trough in 2009 has averaged about 2.25%. Driven by continued stronger consumer spending and employment gains, the recovery should continue through 2018 with an annualized growth rate consistent with or slightly better than the average rate this cycle. Lackluster business spending weighed on the economy in 2017, but the tax cut legislation should help boost commercial and corporate investment spending in 2018. The economy is now in its 9th full year of expansion making it the third longest since records have been kept.
The U.S. economy continues to exhibit signs of stable underlying growth. In its latest report, the monthly index of leading economic indicators has shown increases in 90 of the last 102 readings. U.S. car and light truck sales had a third consecutive year of strong gains even though 2017 sales were modestly lower than those in 2015 and 2016. Automakers sold 17.2 million vehicles in 2017. This is the first time the industry has cleared the 17 million mark for three consecutive years. Buyers took advantage of cheap gasoline prices and low-interest rates along with employment gains to spur auto sales.
2017 was another year of solid job gains due to employment growth that added approximately 2,000,000 jobs. December marked the 87th straight month employers added to payrolls, the longest streak on record. The current labor market expansion is more notable for its length than its strength. Payrolls grew by better than 2.5% annually during the economic expansions in the 1960’s, 1980’s and 1990’s. Payroll growth has only topped 2% once in the current upturn, which was in 2014.
The U.S. industrial economy continues its modest improvement during the current recovery. U.S. crude oil production is expected to surpass 10 million barrels per day during 2018. U.S. crude oil production and domestic automobile production have been positive drivers to economic growth and should continue to have a positive impact in 2018. About 70% of total U.S. output goes towards domestic consumer spending. Incomes are generally outpacing spending with the savings rate amongst consumers holding around 3%, down from about 5.5% one year ago.
Inflation was up 2% year over year in 2017. Investors continue to question whether improving economic data will finally spark higher inflation. For years, both bond investors and economists have debated whether tentative signs of rising prices will take hold. So far, inflation has remained stubbornly low even as the economy accelerates. However, inflation is bound to pick up if the labor market continues to improve and energy prices continue to climb.
As we have noted previously, the U.S. economy continues to be in a modest expansion relative to the recession that preceded it. There continue to be no shortages of both domestic and international geopolitical shocks that could create volatility for the U.S. economy or markets.
Capital market returns were positive in 2017. Large capitalization stock returns, as measured by the S&P 500, were up 21.8%. It was also the ninth consecutive quarter for positive gains for the S&P. Smaller capitalization stocks, as measured by the Russell 2000, increased 14.6%. Investment grade short to intermediate taxable bonds generally returned in a range of 2-5% depending on average maturity length. In 2018, we continue to expect that stocks should provide returns that mimic long-term earnings growth (7-9%). Our outlook again anticipates stocks outperforming bonds.
Other 2018 forecasts include moderate growth with no recession on the horizon. Economic growth will likely lift earnings and benefit stocks. The Federal Reserve has been tightening monetary policies for two years mainly through rate hikes. This is likely to continue with two or three rate increases in 2018 as inflation reaches or exceeds the Fed’s target.
All in all, global economic growth and increased earnings growth should help propel equity prices higher but not to the rates of return seen in 2017.
Authored by Joe Ford, Chief Economist