Over the past few months, it has become abundantly clear that the U.S. economy is slowing down. It took much too long for Fed Chairman Powell and most of his fellow FOMC members to see the contemporaneous data that most of us on Wall Street had been observing for weeks. GDP growth this year is likely to be about 2% (+/-), whereas growth last year came in at about 3%. The second half of this year is likely to be stronger than the first. Inflation remains at less than 2%, even as employment and wages continue to rise at a modest pace. The benefits of globalization, technological advances and many intensely competitive on line retail markets are all keeping a lid on pricing power. Moreover, money supply growth and bank lending are proceeding at non-inflationary rates. Corporate profits rose about 20% last year, benefiting significantly from the reduction in the corporate tax rate. In the context of a 2% growth rate economy, profits this year are likely to advance at less than a double digit pace. Nevertheless, we continue to expect that S&P 500 earnings will reach $170 this year. At 2800, the Index is valuing this outcome at 16.5 times, for an earnings yield of 6.1%, still significantly above corporate bond yields.
At this writing, the S&P 500 has advanced 11.1% since the beginning of the year. While this is outwardly a very large number, bear in mind that stock prices declined by 14% in the fourth quarter of 2018, before the FOMC came to its senses and reversed its policy of monetary tightening. As we noted last month, market volatility is likely to remain high. We expect to take advantage of price corrections to initiate or add to positions in well situated companies.
As always, there are risks to any forecast. We believe there is little chance that the US economy will overheat any time soon, which would bring forth a tighter monetary policy. On the contrary, the risks to growth stem largely from international and geopolitical factors, all of which are well known. We do keep an eye on the strength of the US Dollar, as it affects both our exports and the translation of foreign-source earnings. Growth in Europe has slowed to a crawl. Growth in China also continues to come down. China is now using both fiscal and monetary stimulus to increase its growth rate. The ECB continues to pursue an accomodative monetary policy, as does the Bank of Japan. If a trade deal with China is not soon forthcoming, and if the Administration raises tariffs sharply against not only Chinese imports but also those from the European Union, then all bets are off, and our forecast and our investment strategy will change dramatically to a maximum defensive posture.
