December 12, 2017

4th Quarter Economic Review:

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The 2017 economy has benefitted on the momentum created in February by the idea that a new tax bill could be introduced and signed by the New Year 2018. As you can see by this chart, the closer we are getting to that date and the higher the likelihood of its passage is resulting in a steeper incline in the DJIA. The Dow is breaking through new barriers on what seems like a weekly basis. The unemployment rate is down to 4.11%, a level considered full employment. Nonfarm payrolls rose 228,000 in November exceeding almost all expectations. However, what could have been considered a very strong unemployment report was offset by average hourly earnings, which were on the weak side.

As I mentioned, the tax bill is one of the major beams supporting the confidence in the business community. However, we are not certain how the final version will read. The bill passed by the House is unrecognizable when compared to the bill passed in the Senate. As the 2 versions go through the process of consolidation, we should get a better picture in the coming weeks.

Clearly we are seeing strength in the stock market. We are not seeing the same strength in the bond market…yet. Short terms rates continue to rise as long term rates subtly decline. This is causing a flattening in the yield curve. In the chart below, you can see the difference in the yield curve today versus one year ago. The yellow track represents one year ago and you can see the steepness when compared to the red track representing today’s yield curve. The difference is one year ago, an investor was paid to extend out on the curve. Today, an investor is not paid for extension and it would be encouraged to purchase bonds on the shorter end of the curve. The long end of the curve remains anchored down by the performance of world economies. I have mentioned several times in the past that as long as the US remains the “best deal in town”, there is little reason for long term rates to increase.

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Wednesday of this week the FOMC is meeting and all expectations are they will raise rates for a fifth time since December 2015. This will be Janet Yellen’s last meeting. The ECB meets Thursday of this week and all expectations are their bond purchase program will begin to taper. The European economy is growing at a rate that the pace of tapering may be higher than initially reported. In the long run this could help ease the anchor holding down long term rates in the US.

The bottom line is we seem to be entering 2018 with some positive economic momentum which began in the beginning of 2017. The NFB small business optimism index is at its highest since 1983. 24% plan to add jobs with increases in hiring plans for construction, manufacturing, and professional services. This is clearly anticipating further upticks in economic growth. This growth is starting to cause some unsettling feelings in China. Rates in China are increasing and they are fearful of market volatility. Combined with the lure of higher US interest rates and a more competitive US tax code, China is expecting this will pull capital out of the country and back to the US.

Nathan Purdy