What Lies Ahead for the Economy and Markets?

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on May 16, 2019 12:21:14 PM

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economy and marketsThus far, it has been an eventful year. Markets were up substantially, pulled back sharply, and then bounced again. The economy was slow going into the year, picked up during the first quarter, and now may be slowing again. The political story has included the Mueller report, a China trade deal and then trade war, and Brexit (now postponed). Like I said, it has been an eventful year—and it is only May.

The value of forecasting

I am now working on my forecast for the rest of the year, and I have to admit that I am struggling a bit. With both the economy and markets at yellow light status (per my recent economic and market risk updates), with the 2020 election on the horizon, with the trade war heating up, and with Brexit postponed but still looming, there are a number of wild cards out there. Add in the pending debt ceiling fight between Congress and the White House, which is the real potential deal breaker, and anyone trying to forecast has their hands full.

That said, I do think it is useful to try to game out the most likely course of events. Now, we know we will be wrong in many ways. But by comparing what does happen with what we think will happen, we can monitor in real time whether things are going as planned—or whether we need to make some changes. This is the real value of a forecast: a guide to how we are wrong, and what changes we need to make. So, what should we expect from the economy and markets for the rest of the year, and what might we be wrong about?

Continued growth

The first expectation is continued growth for the rest of the year. We have never had a recession with job growth as strong as it is, with confidence where it is, and with the yield curve positively sloped. So, if we have a recession any time soon, it would be the first time ever on multiple dimensions. I don’t think things will be that different this time. As such, growth will continue. Some slowing is very likely, as first-quarter growth came from unsustainable sources. But slow growth is still growth.

New highs for market

The second expectation is that the market will reach new highs by the end of the year. With earnings expectations low and growth expected to continue, some modest further appreciation is reasonable on rising earnings and positive surprises. How long this growth lasts is an open question. But a couple more quarters—to the end of this year—looks like the most reasonable case.

Possible disruptors

The expectation for the rest of the year, then, is surprisingly positive. It will likely be quite similar to earlier years in this recovery, with modest growth and market appreciation. Looking at these expectations, however, we can also see where they could break. The baseline assumption here is that current trends will continue. Many of the political risk factors I mentioned earlier could break that assumption, as we could have seen with the recent resumption of the trade war.

This framework also gives a way to look at these potentially disruptive events. When we see an event, we can also try to determine whether the economic damage is sufficient to actually disrupt. The trade war, for example, will do immediate damage of around $30 billion. This damage isn’t nothing, but in a $20 trillion economy, it isn’t really material either. So, we would expect a moderate reaction (which we got) but not a worse one.

Overall, this is what I am looking at for the rest of the year: continued modest growth in both the economy and markets. Risks are largely political, but they could be large enough to derail that prediction—but certainly don’t have to be.

A good place to be

When you look back at the recovery so far, this is actually pretty much exactly where we have been for the past 10 years. Indeed, the concerns are real. But in the biggest picture, the rest of 2019 is likely to look very much like what we have become accustomed to—and that is a pretty good place to be.

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