The U.S. economy remains solidly in a mid-cycle expansion, with the housing recovery and supportive credit conditions helping to boost consumer and business sentiment.
There is evidence that growth in the U.S. manufacturing sector is moderating, and global economic indicators have been disappointing recently. Yet accommodative monetary policies in the U.S. and internationally have provided liquidity in the financial markets and helped to sustain a modest pace of economic growth (see the U.S. Economic Indicators Scorecard below).
Recent trends in major categories
The following is a more detailed look at developments in major areas of the economy.
The corporate sector remains one of the healthiest in the U.S. economy, with strong balance sheets and high profitability so far providing durability to the expansion. Up 3.3% from a year ago, S&P 500 earnings finished above expectations in the first quarter.1 However, disappointing revenue growth and negative company guidance for future earnings have raised questions about whether profit growth will be strong enough to support higher stock prices going forward (see "Outlook for corporate earnings").
Corporate capital expenditures have held up well, with new orders for core capital goods increasing in April for the second straight month and growing nearly 6% since the start of the year.2 Surveys indicate that the outlook for business investment remains constructive. The manufacturing sector continues to grow at a slower rate; the manufacturing purchasing managers’ index declined to 50.7 in April, but 78% of industries reported expansion.3 Also in this report, new orders rose while inventories continued to be drawn down, which bodes well for the outlook, although recent surveys conducted by regional Federal Reserve Banks suggest further moderation in activity.4 While earnings growth and manufacturing activity have slowed, the corporate sector remains healthy and increasingly inclined to raise capital spending.
Inflationary pressures have been muted. April consumer prices fell more than expected on lower gasoline prices, with the year-over-year change of 1.1% the slowest inflation rate since November 2010.5 Excluding energy and food, core inflation increased 1.7% year-over-year, the slowest since June 2011. Improvements in the housing market, employment outlook, and bank lending have created some upward pressure, which has been offset by constrained wage growth. These countervailing forces may keep inflation bouncing around a stable range throughout 2013, while both market and consumer expectations for inflation remain well anchored after moderating since the beginning of the year. Limited wage growth and commodity price gains have kept inflationary pressures under control.
The housing sector remains one of the brightest spots in the U.S. economy. With affordability still near all-time highs, home prices are up 10.9% over the past year—the fastest rate since the housing market peaked in 2006.6 Residential building permits at post-recession highs have almost doubled from their trough in early 2009, and housing construction has been one of the key contributors to economic activity.7 Demand has been robust, with new and existing single-family home sales growth of over 10% over the 12 months through April, while supply, at 4.7 months for single-family homes, remains near its lowest level since 2005. Strong demand and low supply provide a solid backdrop for the housing sector—and positive effects on the broader economy.
The U.S. employment backdrop continues to improve at a moderate pace. Private payrolls increased by 176,000 in April—similar to the average monthly gain over the past three years—and the jobless rate fell to a post-crisis low of 7.5%.8 The National Federation of Independent Business has reported a sharp rise in small businesses expecting to increase payrolls, reflecting improved hiring sentiment. And initial unemployment claims were the lowest in early May since the beginning of 2008, adding more evidence of a gradually healing labor market.9 The environment of slow repair in U.S. labor markets is still intact, as the benign economic outlook and a strong private sector have offset the negative effects of the government’s retrenchment.
U.S. consumers have benefited from limited inflation, the robust housing market recovery, and a relatively stable employment situation, which have all helped to support positive spending trends. Core retail sales—stripping out volatile gasoline, auto, and building supply expenditures—beat consensus expectations in April with growth of 3.6% from the prior year.10 Lower gasoline expenditures gave consumers more money to spend in other retail markets compared to a year ago. Boosted by rising perceptions of current economic conditions, consumer sentiment in May jumped to its highest level since 2007.11 Consumer spending has been growing at a relatively steady rate, with a positive outlook thanks to low inflationary pressures and ongoing labor market repair.
Credit markets and banking
Credit conditions in the U.S. and globally have become even more favorable as central banks around the world have eased monetary policy and increased liquidity in financial markets. The Federal Reserve Senior Loan Officer Survey released in early May showed a significant increase in banks’ willingness to lend to consumers and corporations. Robust investor demand for yield-bearing assets has reinforced this trend, with bank loan—or floating-rate debt—mutual funds attracting more than $22 billion of inflows through the first four months of 2013, eclipsing every full-year total since 2003.12 After dipping in mid-April, the Bloomberg Financial Conditions Index has improved steadily to the best reading since 1997 (see chart, right). The easy monetary policies of the Fed and other central banks have supported strong credit and financial conditions, and few signs point to an imminent change in that policy stance.
The global economic backdrop has gained momentum recently, with 79% of the 39 largest economies showing increases in leading indicators over the past six months. But the pace of growth has remained disappointing, particularly given the amount of monetary stimulus being pumped into global financial markets: 27 different economies, including the 17-country eurozone, have cut policy interest rates over the past three months.13 Europe is still in a prolonged recession, but there have been some tentative signs of stabilization. Manufacturing new orders have expanded more than inventories in the U.K., Germany, and France—evidence that early-cycle momentum may be building in the core of Europe.
Japan has exhibited strong early-cycle dynamics as it continues to benefit from economic reform policies. The yen has declined by more than 20% on a real trade-weighted basis since last year, creating a tremendous tailwind for the profitability of Japanese corporations—especially considering that they streamlined cost structures to accommodate the previously strong yen (see Viewpoints, “Time in invest in Japan?").
After emerging from a shallow growth recession, China’s recovery has been disappointing. Despite abundant credit, the Chinese economy has yet to respond robustly—a symptom of growing structural imbalances. Other emerging economies are a mixed bag, with commodity-exporting countries, such as Russia, exhibiting softness recently as raw industrials commodity prices have seen little sustained movement up or down over the past two years (see chart, right). Accommodative monetary policy continues to buoy the global economy, which remains in a sluggish, yet positive stage of growth.
Summary and outlook
Global economic conditions remain relatively trendless, with mostly disappointing data releases obscuring an underlying—albeit uneven—aggregate improvement. Recent disinflationary data, including some weakness in commodity prices, reflect the struggle for China and emerging Asia to regain traction. But the lack of inflation is good for consumers and commodity-importing economies, and gives global monetary policymakers plenty of leeway to maintain their extraordinarily accommodative support.
The U.S. economy remains in a slow, mid-cycle expansion. Ongoing improvement in housing, employment, and credit is offsetting the drag from fiscal austerity measures. Though the long-term government debt outlook is still bleak, the Congressional Budget Office projects the fiscal deficit will fall to an unexpectedly low 4% of GDP in 2013, down from 10% in 2009. This fiscal progress has helped to keep policy risk off the front burner. Under current legislation, the fiscal drag on the economy will actually ease moving into 2014. The stronger U.S. dollar has further muted inflationary pressures and held gasoline prices in check for U.S. consumers, while the Fed’s quantitative easing continues to bolster asset markets and corporate earnings (see “Outlook for corporate earnings”).
Given this generally favorable cyclical backdrop, the asset allocation outlook still favors economically sensitive asset classes such as equities. However, after the rally in riskier asset categories over the past several months, asset prices now reflect more of these positive dynamics, implying a less attractive risk-return outlook.
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The Typical Business Cycle depicts the general pattern of economic cycles throughout history, though each cycle is different and specific commentary on the current stage is provided in the summary and outlook section. In general, the typical business cycle demonstrates the following:
• During the typical early-cycle phase, the economy bottoms and picks up steam until it exits recession, then begins the recovery as activity accelerates. Inflationary pressures are typically low, monetary policy is accommodative, and the yield curve is steep. Economically sensitive asset classes such as stocks tend to experience their best performance of the cycle.
• During the typical mid-cycle phase, the economy exits recovery and enters into expansion, characterized by broader and more self-sustaining economic momentum but a more moderate pace of growth. Inflationary pressures typically begin to rise, monetary policy becomes tighter, and the yield curve experiences some flattening. Economically sensitive asset classes tend to continue benefiting from a growing economy, but their relative advantage narrows.
• During the typical late-cycle phase, the economic expansion matures, inflationary pressures continue to rise, and the yield curve may eventually become flat or inverted. Eventually, the economy contracts and enters recession, with monetary policy shifting from tightening to easing. Less economically sensitive asset categories tend to hold up better, particularly right before and upon entering recession.
2. Source: Census Bureau, Haver Analytics, Fidelity Investments (AART) as of Apr. 30, 2013.
3. Source: Institute for Supply Management, Haver Analytics, Fidelity Investments (AART) as of Apr. 30, 2013.
4. Surveys include the Business Outlook Survey and the Empire State Manufacturing Survey. Source: Federal Reserve Bank of Philadelphia, Federal Reserve Bank of New York, Haver Analytics, Fidelity Investments (AART) as of May 16, 2013.
5. Source: Bureau of Labor Statistics, Haver Analytics, Fidelity Investments (AART) as of Apr. 30, 2013.
6. Source: Standard & Poor’s, Haver Analytics, Fidelity Investments (AART) as of Mar. 31, 2013.
7. Source: Census Bureau, Haver Analytics, Fidelity Investments (AART) as of Apr. 30, 2013.
8. Source: Bureau of Labor Statistics, Haver Analytics, Fidelity Investments (AART) as of Apr. 30, 2013.
9. Source: Bureau of Labor Statistics, Haver Analytics, Fidelity Investments (AART) as of Apr. 30, 2013.
10. Source: Census Bureau, Haver Analytics, Fidelity Investments (AART) as of Apr. 30, 2013.
11. Source: University of Michigan, Haver Analytics, Fidelity Investments (AART) as of May 17, 2013.
12. Source: EPFR Global, Haver Analytics, Fidelity Investments (AART) as of Apr. 30, 2013.
13. Major economies included in the Global Leading Indicators Diffusion Index are: Austria, Belgium, Brazil, Canada, China, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, India, Indonesia, Ireland, Italy, Japan, South Korea, Luxembourg, Malaysia, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Russia, Slovakia, South Africa, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey, United States, United Kingdom. Source: country statistical organizations, Haver Analytics, Fidelity Investments (AART) as of Apr. 30, 2013.