Avalon produces a variety of investment commentaries.
Our perspectives and quarterly commentary are issued throughout the year and cover a range of investment-related topics.
April began with tariffs and trade dominating the headlines. By the end of the month, talk of trade wars was difficult to find as the Korean Peninsula took over the headlines. The economic data was mixed with inflation appearing imminent in some places and blasé in others. GDP growth for the first quarter was strong, and it should continue—notwithstanding political and other distractions.
The U.S. labor market remains strong. For the first two months of the year, goods-producing job creation dramatically outperformed. This reverted in March as construction employment contracted (probably due to the slew of wintry storms). Will this bounce back in April as the weather (presumably) becomes less of an issue? Possibly.
Moving to wages, there was no disappointment, but also nothing to get excited about in the data. Instead, wages continued to bounce around the 2.5% mark.
This has been the trend since late 2015, and there does not appear to be any underlying reasons to believe that wage growth will surge from here. Part of that is due to the waning surge in goods-producing industries. Goods-producing industries have average weekly earnings 28% higher than services providing ones. This "mix shift" in employment creation is another subtle, but no less relevant, caveat to the wage inflation theme.
The CBO Report
The Congressional Budget Office (CBO) released its report on the U.S. economy, including its expectations for growth and (most importantly) the U.S. deficit. The CBO’s report should be taken with a grain of salt, as the report has some laughable assumptions. For example, no recession is apparent over the 10-year horizon. There is also the 4% nominal fed funds rate peak in the fourth quarter of 2020 and the 3% fed funds rate that persists following that time frame. Meanwhile, the 10-year creeps up to a 4.3% peak in the second quarter of 2021. Neither is likely to be realized.
These estimates should generally be ignored, or at a minimum, deeply discounted. But the CBO report is not all laughable. It contains some interesting tidbits of useful information that should not be ignored.
The CBO also makes the point that the deficit is set to balloon. That should come as a surprise to no one. Even with a positive growth feedback of $1T in tax revenues, debt held by the public is expected to reach 100% of GDP by the late 2020s. That is not a positive, and it will crowd out private investment. The U.S. debt will probably make it to 100% of GDP far more quickly, as it only takes a single recession between now and then to push it there.
Core inflation and the headline met expectations of 2.1% and 2.4% respectively. But what was surprising was the general weakness outside of the usual suspect, shelter. Granted, core pressures are higher from a year-ago, but the near-term negative pressures may be persistent enough to significantly weigh on inflation outcomes in coming months.
This indicates that inflation readings will be choppy as the data rolls through last year’s weakness, but the underlying pressures are not accelerating. If anything, the underlying data is incrementally weakening.
As for European inflation, on a country level, inflation pressures remain lackluster. France is one of the few countries where core inflation pressures appear to be building, but, again, the inflation pressure has only pushed core CPI to 1% in France, and there are no signs that inflation is about to run rampant. Germany remains at a comfortable 1.3%, and Spain and Italy have both recovered to reasonable levels. Inflation has become one of the more confusing themes to deal with globally.
Source: Bureau of Labor Statistics
Overall, April confirmed suspicions rather than clarifying anything on the economy. The inflation and wage dynamics continue to be murky with little clarity into the sustainability of current trends. U.S. growth remains strong, but the growth rate is decelerating. Europe is doing well and does not appear to be overheating. If anything, European inflation is running too slowly for comfort. While political and trade headlines might have some effect on sentiment, the fundamentals of the U.S. economy are healthy. There is little reason to suspect this dynamic shifts in the medium term.
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Quarterly and Monthly Notes
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Fourth Quarter, 2016
Third Quarter, 2016
Second Quarter, 2016
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