FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
November 1, 2016
- 3Q Advance GDP Report Came in Stronger Than Expected
- Which US Presidents Have Been Best For the Economy
- Global Bond Markets Suffer Worst Losses Since 2013
- Odds of Fed Interest Rate Hike in December Are Increasing
Overview
We will touch on several bases today. I must admit that it was so tempting to devote today’s E-Letter to a discussion about the presidential election one week from today, especially with all the recent twists and turns in this race.
But the fact is, these are two of the worst presidential candidates I can ever remember. So I’ll spare you my political thoughts today. I do have an interesting section below on which US presidents have been best for the economy dating back to President Eisenhower in 1953. Hint: President Obama ranks dead last!
[drizzle]Following that discussion, we’ll take a look at the global bond market which has taken a hit over the last couple of months. Bonds worldwide lost almost 3% in October alone, the largest monthly loss since May 2013. The question is whether this is just a “correction” or the beginning of a new trend?
Before we get into those discussions, let’s take a look at last Friday’s stronger than expected GDP report for the 3Q. The advance report showed growth well above the pre-report consensus. Most analysts concluded that the door is now wide open for the Fed to raise short-term interest rates in December. I’ll give you my latest thoughts as we go along today.
3Q Advance GDP Report Came in Stronger Than Expected
The US economy grew at its fastest pace in two years in the third quarter as a surge in exports and a rebound in inventory investment offset a slowdown in consumer spending. Business investment improved last quarter, although spending on equipment remained weak.
Gross domestic product increased 2.9% (annual rate) in the 3Q after rising at a 1.4% pace in the 2Q, the Commerce Department said on Friday in its first of three estimates. The pre-report consensus called for a rise of 2.5%, so the advance report was better than expected. That was the strongest growth rate since the 3Q of 2014.
Over the first half of the year, GDP growth had averaged just 1.1%, and some forecasters feared that we might be headed for a recession. Those fears have largely disappeared after Friday’s better than expected GDP report.
GDP Report
Consumer spending which accounts for almost 70% of GDP rose only 2.1% in the 3Q, down from the robust increase of 4.3% in the 2Q. Yet despite the moderation in consumer spending, the 3Q rise of 2.9% in GDP dispelled any lingering fears the economy was at risk of stalling. But not all the news on consumer spending was bad.
Consumer spending on long-lasting durable goods, such as cars and appliances, rose by better than 9% in the past two quarters. Yet overall spending was held back by a decline in purchases of goods which are not meant to last long (non-durable goods). With a tightening labor market generating increases in wages and strong household balance sheets, spending could accelerate in the 4Q, analysts suggested.
Exports, which add to GDP, increased at a 10% rate in the 3Q, the best gain in nearly three years. Export gains had slumped over the prior year and a half, in part because a stronger dollar made US goods more expensive overseas.
Friday’s GDP report gave voters their last comprehensive look at the economy’s health before the November election. The improvement could give Democratic presidential nominee Hillary Clinton more latitude to position herself as the candidate to continue Obama administration policies that have led to a long expansion.
Still, the most recent gain comes in the weakest expansion in recent memory, a point Republican candidate Donald Trump makes frequently. Since the recession ended in mid-2009, the economy has grown at just under a 2.0% annual rate, making the current expansion the weakest on record dating back to 1949.
In fact, if we look at the same GDP data on a rolling 12-month basis, the economy continues to falter. Even if the 4Q produces close to 3% growth again, the full-year GDP growth rate for 2016 is likely to be around 2.0%, even lower than the anemic 2.4% growth rate in 2015.
This is not a pretty picture! Keep in mind that Friday’s advance GDP report was the first of three such estimates which will be revised again (up or down) at the end of November and December.
Which US Presidents Have Been Best For the Economy
With one of the most important presidential elections in our lifetimes just one week away, and with two of the most polarizing and controversial candidates in recent memory, the US economy remains issue #1 for most Americans.
With that in mind, I thought we would take a look today at which US presidents in recent history have been the best and worst for the economy among the last 11 occupants of the White House. We judge them by the average quarterly GDP growth while in office dating back to 1953.
President John F. Kennedy ranks #1 on the list. President Kennedy, while a Democrat, had a very conservative, pro-growth agenda consisting of tax cuts for businesses and lower marginal income tax rates across the board. His tax reductions were aimed at increasing incentives for work, saving and investment.
Kennedy’s business tax cuts became law in 1962, and his tax decreases on personal income were enacted in 1964, just a few months after his assassination. The changes in economic behavior that accompanied his policies were among the most rejuvenating and long-lasting in the post-World War II era. The economy grew at a rate of 5.5% on President Kennedy’s watch.
President Lyndon B. Johnson was smart enough to continue Kennedy’s pro-growth policies for the most part during his presidency from 1963 to 1969. The economy grew at a rate of 5.1% on President Johnson’s watch.
President William J. Clinton is third on the list with average economic growth of 3.8% during his two terms from 1993 to 2001. Clinton presided over the longest peacetime economic expansion in American history. In 1993, Clinton cut taxes for 15 million low-income families, made tax cuts available to 90% of small businesses and raised taxes on the wealthiest 1.2% of taxpayers – which he was most known for.
In 1997, the Republican-led Congress passed a tax-relief and deficit-reduction bill that was initially resisted but ultimately signed by President Clinton. That bill lowered the top capital gains tax rate from 28% to 20%, created a new $500 child tax credit, established tax credits for higher education, created the Roth IRA, etc. Clinton later acknowledged that the tax cuts were a benefit for the economy.
President Ronald Reagan is next on the list with average economic growth of 3.6% during his two terms from 1981 to 1989. Ronald Reagan’s presidency was propelled by pro-growth tax cuts and deregulation. Gross Domestic Product soared by 34% during his eight years in office.
President Barack H. Obama ranks last on the list with average economic growth of only 1.78% from 2009 to the end of 2015. Mr. Obama’s presidency has been marked by multiple tax increases and pervasive regulatory expansion. Gross Domestic Product has risen by only 14% during his presidency, as compared to 34% under President Reagan.
In fairness, I should acknowledge that President Obama’s 1.78% average economic growth is only marginally lower than that of President George W. Bush at 1.80%.
The point is that the economy has been considerably stronger under presidents that lowered taxes and slowed regulation, as opposed to those that raised taxes and increased government regulation. Obviously, this is a big issue in this year’s presidential election.
Global Bond Markets Suffer Worst Losses Since 2013
After all that central bankers have done since the financial crisis to prop up bond prices and drive interest rates down to record levels, it didn’t take much to send the global debt markets reeling over the last month or so.
Bonds worldwide lost almost 3% in October, according to the Bloomberg Barclays Global Aggregate Index, which tracks everything from sovereign debt obligations to mortgage-backed securities to corporate borrowings.
The last time the bond world was dealt such a blow was May 2013, when then-Federal Reserve Chairman Ben Bernanke signaled that the central bank might slow its unprecedented QE bond buying program (the so-called “Taper Tantrum”).
The chart above shows the US 10-year Treasury Note, the 10-year German Bund and the 10-year British Gilt – all instruments of government debt. A rise in yield causes a decline in bond prices.
Europe led the losses that reverberated worldwide in October as signs of economic growth and rising inflation spurred speculation that the European Central Bank and its major counterparts are moving closer to curbing monetary stimulus, including bond purchases.
The result is that investors are abandoning one of the year’s biggest trades — a bet on even lower yields and higher bond prices — as they wake up to the limits of central-bank demand that drove bond yields to record lows as recently as July.
Portfolios, banks and hedge funds have stocked up on these government bonds in recent years as interest rates continued to decline. The assumption was that global central banks would continue buying bonds for years and rates would continue lower. That assumption is changing.
In a year in which global bonds have earned 6.7%, it’s been months since yields were this high in Europe. Yields on 10-year British gilts reached 1.3%, the highest since June 23, the day of the UK vote to leave the European Union.
Similar-maturity German bonds were set for their worst month since 2013, pushing yields to 0.217%, a level last seen in May. US 10-year Treasury yields touched 1.88% last week, the highest since May.
There’s potential for more turbulence just ahead. This week brings interest-rate decisions from the Bank of Japan, the US Fed and the Bank of England. Then on November 8, Americans go to the polls to choose a new president.
As a result, many bond buyers around the world are trimming their positions, which puts more downward pressure on bond prices. This is not to say that bond yields will continue to rise. Maybe this is just an overdue “correction.” Then again, maybe it’s more than that.
Odds of Fed Interest Rate Hike in December Are Increasing
Last Friday’s US GDP report showing the best growth in over a year didn’t help matters either. Stronger growth usually means higher interest rates to head off inflation. The odds of a Fed Funds rate hike at the December 13-14 Fed Open Market Committee (FOMC) meeting are now north of 70%.
As regular readers know, I have been predicting that the FOMC will hike at the December meeting for months now. I did not think the Fed would hike at the July or September policy meetings. I also do not think the Fed will hike at this week’s policy meeting which began today, since there is no post-meeting press conference for Fed Chair Janet Yellen tomorrow.
Yet with the 2.9% increase in 3Q GDP, well above expectations, the door is wide open for the Fed to raise the rate by another 0.25% in December.
I will have more to say about this as we approach the December 13-14 FOMC meeting, but I will be very surprised if Yellen & Company don’t vote to raise the Fed Funds rate by another quarter-point at that time. If so, that could mean another setback for stocks and bonds.
All the best,
Gary D. Halbert
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Article by Gary D. Halbert
