Over the past seven and a half years, GDP (gross domestic product) growth has advanced at an average annual rate of 2.1%. While the current recovery has stretched longer than most (the average is closer to five years), it may not have reached its full potential. Historically, the economy has grown 23% over the prior peak before a decline begins. The GDP is now only 11% higher, so there may still be room for expansion.
While there’s never a guarantee, many Capital Group investment professionals expect modest growth to continue in 2017 and see trends that inspire an optimistic outlook for the U.S. economy:
A stronger consumer is driving growth, as Americans have responded positively to a boost in take-home pay with an increase in consumer spending. What’s more, the 4.6% unemployment rate is less than half of what it was in 2009, which bodes well for economic gains. Jared Franz, a macroeconomic analyst at Capital Group, notes, “If you look at previous cycles, the growth could last more than two years after the economy hits full employment, and we’re just reaching that point now.”
While these positive indicators are encouraging, “it’s not just the health of the consumer,” notes portfolio manager Martin Romo. “We’re also closely watching consumer behavior.” Companies that could benefit from continued robust consumer activity include home improvement stores, travel companies and credit card issuers.
When the Federal Reserve increased the interest rate in December 2016, it was only the second time it had done so since 2006. The previous hike had been back in December 2015. As the economy becomes more stable, it’s likely that we will begin to see rates gradually rise. That’s not necessarily a bad thing. While it could affect new borrowers, it won’t raise rates on current loans, like mortgages. Additionally, it could help those living on retirement income and reward those who are savers. Also, banks may make credit more accessible as lending becomes more profitable for them. “If the economy continues to strengthen, and you see some inflation and higher interest rates, that would help margins for the bigger banks,” says Martin.
Rebounding Corporate Profits
After years of gains, most U.S. stocks appear fully valued — with price-to-earnings ratios (the price of a stock divided by its earnings per share) above the S&P 500’s long-term average. Low oil prices, weak industrial activity and a strong U.S. dollar have dampened corporate profits. These headwinds could become weaker in 2017, enabling some industries to turn the corner.
Portfolio manager Mike Kerr expects oil prices to stabilize above current levels. “I think oil prices have bottomed,” he says. “I don’t think we are going back to $100 [per barrel], but if oil prices return to the $60 range, that would affect capital spending in the U.S.” The improved profitability of energy companies could benefit other sectors as well, particularly industrials and materials. “U.S. industrials are definitely involved in the capital cycle of the oil industry,” Mike adds. “So if the price of oil climbs from $50 to $60, there is going to be a fairly significant increase in capital expenditures in the oil industry — and that is a big benefit for many companies in the industrial base. It is a big benefit for railroads as well.”
Industrial activity could be poised for a turnaround during the next administration. Both political parties advocated for improvements in infrastructure, so legislation could be approved, and President-elect Trump’s promised stimulus package could provide an additional boost. The defense industry stands to gain as well, with expected increases in capital being allocated in the coming years. Uncertainty over the direction of the incoming administration may linger for months. However, concerns about future trade policies may be partially offset by the prospect of lower corporate taxes and other business-friendly initiatives.
Meanwhile, the rising value of the U.S. dollar appears to be slowing, which is good for exporters. U.S. exports have been a weaker part of the economy, but that could change going forward as they benefit from greater buying power in other countries. “The strength of the U.S. dollar in 2014 and 2015 weighed on S&P 500 companies’ earnings,” says economist Darrell Spence. “Over the past year, the dollar has been roughly flat against most major currencies, and I believe this trend will continue. That could increase profits for U.S.-based multinationals that derive a larger percentage of their earnings from exports.”
These are just some of the trends our investment professionals will be following in the months ahead, as opportunities are still to be found. “It may be hard for people to believe that this recovery will actually continue,” notes Darrell. “When things do start to wobble, as they did early in 2016, investors may worry that it’s the beginning of the end. But I just don’t think the U.S. economy will falter that easily. There aren’t a lot of structural problems.”