She Just Keeps Rolling Along
The economic expansion just keeps rolling along, which is why the equity market, despite assorted nasty political, geopolitical, and weather events, continues to set new highs. These conditions may introduce significant volatility into equity prices on a day-to-day basis. And every three months, companies report profits, which have been rising and significantly better than expected. Many companies have also announced dividends increases, which remind individuals why they hold such investments. As long as there are no signs of recession in sight, market declines are simply buying opportunities.
Investors are currently especially focused or distracted by the hurricane over Florida, as well as risks with respect to North Korea. (Indeed, my condo located near Sarasota appears to be directly in the path of the eye of Hurricane Irma as I write this commentary, so this is hardly theoretical for me.) Nonetheless, Irma should have only a small negative impact on GDP over the next two quarters, as David wrote last week, while spending to rebuild and repair will provide a corresponding small positive bias to the data over the subsequent quarters. (Despite the storm, I still expect to spend some time this winter in my Florida condo.)
Concerns over North Korea should lead to increased U.S. spending on national defense, notably on anti-missile technology, but also more broadly to make up for years of restraint. This may well be part of the package that emerges from the tax and budget negotiations. Washington politics may delay any deal and reduce its scope, but we still expect something to emerge eventually and that something is likely to be pro-growth. The market no longer expects anything positive to come out of Washington on fiscal policy.
Even with all the concerns, the performance of the economy remains steadfast. Growth is holding up extremely well and might be improving slightly, despite the decreased availability of ever scarcer labor. Firms are trying to substitute technology and capital for labor when possible. This is helpful and desirable, yet it can make up for an ever tighter labor market only temporarily. In time, barring some unexpected exogenous event, the effects of labor scarcity will inevitably become manifest as higher inflation. Monitoring the behavior of the various measures of inflation is the key to anticipating changes in monetary policy. The unemployment rate is one key indicator to follow to obtain an early clue on how inflation is likely to behave.
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