March Commentary

As investment managers it is critical we look at all sides of the equation, not just what could go right, but also what could go wrong. In fact, during Allegiant’s Investment Committee meetings I always encourage someone on the team to argue against the consensus opinion. It is through these open dialogues and debates that our best ideas surface. We don’t always get it right, no one does, but we fully grasp both the positive and negative impacts on an investment so that as information changes we can quickly change our opinion if necessary. Having dialogue about multiple potential outcomes beforehand helps limit emotional reactions when those outcomes develop. And, as significant research in the behavioral finance field has shown, emotional reactions generally have negative impacts on investment success.

During this year’s Economic & Investment Outlook Summit the Investment Committee discussed many potential outcomes for the year ahead. A detailed write-up of the major thoughts can be found on our website. However, understanding the upside and downside risks to our base case scenario is just as important as understanding our final thoughts.

First, let me reiterate our base case thoughts for the year ahead. Corporate earnings should continue to grow, with a significant boost coming from a lower corporate tax rate. Corporations will be faced with important decisions with their new cash. Do they embark on capital expenditure programs, increase wages, fill new positions, buyback shares, or increase dividends? It will probably be a mixture of all these, but how they allocate their savings to each will determine how much the economy will benefit. This newfound corporate cash could lead to slightly higher inflation as more dollars will be chasing the same amount of goods. In turn, this could lead to slightly higher interest rates, as the Fed’s near-zero interest rate policy is no longer warranted. Wage growth may finally accelerate as corporations look to fill open positions with a limited supply of available workers. Finally, last year’s increase in soft economic data (expectations-based data) should lead to an increase in hard economic data as elevated levels of confidence translate into real economic growth. Generally, the economy looks to be in pretty good shape in the short-term.

But, what could go wrong? Frankly, since we believe we are in the later stages of the economic cycle, a lot could go wrong. The recent increase in consumer and business confidence could peak and real economic growth may not materialize. Corporations could decide demand is not strong enough for them to re-invest significant amounts of cash, instead opting for share buybacks and dividend increases. While this would lead to a short-term bump in earnings, there would be no lasting impact on the economy. This could lead investors to anticipate a deceleration in economic growth, therefore driving down market valuations. Inflation could accelerate faster than expected, causing more aggressive Fed action, which would stymie growth. Consumer balance sheet issues could emerge, as much of America has not benefited from strong asset price appreciation over the last decade. And, finally, as is always the case, geopolitical risk could spike, causing a quick halt on economic activity.

Not to sound too grim, there are many things that could surprise to the upside as well. One important factor to consider is although this economic expansion is one of the longest in history, the cumulative growth over the expansion is one of the weakest on record. Normally this far into an expansion, the economy begins to overheat and hit structural impediments to growth, but we are not seeing that yet. In fact, the U.S. just recently closed the output gap that built during the last recession. Essentially, output gap is economists’ way of saying the economy is back to where it should be, no higher and no lower. Furthermore, if corporations use a larger than expected portion of their tax savings to re-invest in their businesses this could lead to an investment and hiring boom. While this could be a drag on current earnings, it would be very encouraging for the near-term health of the economy and the long-term health of American businesses. An investment and hiring boom could go a long way toward driving sentiment even higher. If consumers and businesses feel better, they spend more, and the circle continues.

Certainly, an argument can be made for both positive and negative outcomes. That’s why forecasting is so hard to do. However, as the economy stands right now, a majority of the data looks good. It is important to watch where economic numbers go from here, since at any point they can change. Having a predetermined set of possible outcomes will help us adjust as economic activity changes. However, the most critical aspect of successful investing is to make sure that both the portfolio and the investor can withstand any and all of these potential outcomes, without severely impacting the ultimate goals. That’s why Allegiant spends so much time focusing on the management of risk, not just the management of returns.

Below is a complete listing of the major thoughts from our U.S. Economic Outlook. If you would like to see more data and charts about the economy and various financial markets please click here to view our Monthly Insights book, published online at AllegiantPA.com. 

Benjamin W. Jones, CFP?, AIF?

CERTIFIED FINANCIAL PLANNER??

Chief Investment Officer, Principal

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