The Federal Reserve’s Falling Growth Forecasts
Thursday, September 29, 2016

Seemingly overlooked in all of the hubbub about a possible rate hike occurring at the December Federal Open Market Committee (FOMC) meeting is the longer-term trend of falling growth forecasts. FOMC members have collectively reduced their real (“inflation-adjusted”) long-run GDP growth forecasts for at least five consecutive years. The current long-run forecast calls for 1.80% economic growth; in 2011, the midpoint of the forecast range was 2.55%.

At the same time, expectations for long-run inflation essentially have not budged. Since the September 2012 meeting, FOMC members have forecast an increase in personal consumption expenditures (PCE) of 2.0%. (It was slightly lower in 2011, with a midpoint of 1.85% for the typical range of forecasts.) Reported PCE has been staying below the committee’s target, hence allowing interest rates to stay at low levels.

Some of the reasons influencing the downward trend in forecasts are obvious. Job creation has not been strong even though nonfarm payrolls have been increasing and the unemployment rate is at low levels. Wage growth has been disappointing for many workers. Quarterly productivity has worsened eight times since 2011. Budget bickering in Washington has capped fiscal stimulus and many state governments are strapped. The economy in other developed countries has been in a funk. Yesterday, the International Monetary Fund’s managing director, Christine Lagarde, said the overall growth outlook for developed economies “remains subdued.”

From an investment perspective, the falling forecasts are yet another sign that the calls for a bond armageddon occurring are the dog that didn’t bark. Given the ongoing trend in long-run economic forecasts, it’s hard to envision the Fed aggressively raising interesting rates in the foreseeable future. A 25-basis point (0.25%) increase at the December meeting would not change this view. What matters with interest rates is often not the timing of the next rate hike (presuming that it’s small and expected), but rather the perceived magnitude and frequency of the rate hikes that follow it. The CME’s FedWatch Tool currently places a greater than 90% chance on the FOMC's federal fund's target rate not being above 1% a year from now.

Forecasts are always subject to change. Plus, my crystal ball remains cracked. Nonetheless, without a change in the economic climate or some other change, long-term interest rates will remain on track to stay low. Such an environment should continue to provide stability for prices of longer-term, high-quality bonds. It would not be favorable to those seeking higher interest on cash savings or higher yields from fixed-income investments. It also means that annuity purchases should continue to be staggered over a period of time. For stocks, low interest rates help companies finance expansion, but slow economic growth hurts revenue and thereby earnings growth.

There are other potential implications of continued slow growth. To the extent that inflation (and inflation expectations) remains low, purchasing power will be better preserved, or at least eroded by a lesser amount. Tax-related limits will rise more slowly, which keeps the ceiling for inflation-adjusted credits and deductions from changing much, if at all. For example, recently predicted that the annual limits for 401(k) deferrals and catch-up contributions will stay at $18,000 and $6,000, respectively, in 2017. Similarly, low inflation could mean a small increase in Social Security benefits. The Social Security Board of Trustees projected a 0.2% cost-of-living adjustment for 2017. The actual numbers for 2017 have not been released.

For those of you who remain frustrated, there are few things you can do. Avoid the temptation to take on more risk in an effort to get higher rates of return or higher yield. Such strategies can backfire in a painful way. Save more if possible. Most importantly, stay disciplined and think long-term. Economic and market conditions change over time, often without much warning and in ways we don’t anticipate.

SEC Proposes Two-Day Trade Settlements

Yesterday, the Securities and Exchange Commission (SEC) proposed a rule shortening the amount of time it takes to settle a trade from three days to two days. Currently, when you sell a stock or security, the cash from the transaction is not available for three days. Brokers will allow you to use the proceeds to buy another security immediately, but the funds are not available for withdrawal until three trading days afterward.

A fact sheet about the rule change is on the SEC’s website. A link to the proposed rule is on the right-hand side of the page, under “Related Materials.” (It’s easy to overlook the link.) Public comments on the rule will be sought for 60 days following the publication of the rule in the Federal Register.

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Highlights from the AAII Journal

The Week Ahead

October starts on Saturday. Infamous for the 1929 and the 1987 crashes, October actually tends to be a fairly ordinary month when it comes to returns. Stocks have experienced worse average monthly returns in May, February, August, June and September since 1950, according to the Stock Trader’s Almanac.

The Jewish High Holy Days start on Sunday evening with Rosh Hashanah. L’shanah tovah to those of you who will be observing the holiday.

Seven S&P 500 companies will report earnings: Darden Restaurants (DRI) and Micron Technology (MU) on Tuesday; and Acuity Brands (AYI), Constellation Brands (STZ), Global Payments (GPN), Monsanto (MON) and Yum! Brands (YUM) on Wednesday.

The week’s first economic reports of note will be the September purchasing managers’ manufacturing index (PMI), the September ISM manufacturing survey and August construction spending, all of which will be released on Monday. Wednesday will feature the September ADP Employment Report, August international trade data, August factory orders and the September ISM non-manufacturing survey. September jobs data—including the change in nonfarm payrolls and the unemployment rate—will be released on Friday.

Six Federal Reserve officials will make public appearances: Chicago president Charles Evans on Tuesday; Richmond president Jeffrey Lacker on Tuesday and Wednesday; and Fed vice chairman Stanley Fischer, Cleveland president Loretta Mester, Kansas City president Esther George and Fed governor Lael Brainard on Friday.

What’s Trending on AAII
  1. How Interest Rate Changes Affect the Price of Bonds

  2. Investing to Avoid the Consequences of Being Wrong

  3. Retiree Portfolios and Warren Buffett’s Allocation Instructions

AAII Sentiment Survey

The percentage of individual investors expecting stock prices to rise is down for a third consecutive week. Neutral sentiment rose, while pessimism pulled back.

Bullish sentiment, expectations that stock prices will rise over the next six months, declined 0.8 percentage points to 24.0%. Optimism was last lower on June 22, 2016 (22.0%). This is the 47th consecutive week and the 80th out of the past 82 weeks with a bullish sentiment reading below its historical average of 38.5%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rose 2.0 percentage points to 38.9%. The increase puts neutral sentiment above its historical average of 31.0% for the 35th consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, pulled back by 1.2 percentage points to 37.1%. Pessimism is above its historical average of 30.5% for the third consecutive week and the fourth time in five weeks.

This is the sixth consecutive week with fewer than three out of 10 individual investors expressing optimism about the short-term direction of stock prices. It is also the third consecutive week that bullish sentiment is at an unusually low level (more than one standard deviation below average). The typical long-term range for optimism is 28.1% to 48.7%.

The downward volatility that occurred last Friday and Monday likely did not help investor sentiment, as many individual investors fret about the possibility of a sizeable drop occurring. The election is also creating uncertainty among some individual investors. Further adding to pessimism about the short-term direction of stock prices are concerns about valuations, global economic uncertainty and the pace of corporate earnings growth. Giving other individual investors reason for optimism are this summer’s rise in stock prices, the perceived lack of investment alternatives, corporate earnings, low/stable energy prices and sustained, albeit slow, economic growth.

This week’s special question asked AAII members for their opinion about how clearly the Federal Reserve is communicating its monetary policy intentions. More than four out of every 10 respondents (44%) are not satisfied with the Fed’s communication about monetary policy. These respondents described it as being unclear, poor, inconsistent or needing improvement.  Not all individual investors feel this way. Approximately 31% of respondents say the Fed is being clear or is doing a good job of communicating its intentions for monetary policy.

Here is a sampling of the responses:

  • “Not very, at least as far as the timing of the increase goes.”
  • “I don’t feel that they are clearly communicating.”
  •  “The Fed appears uncertain as to when they will raise interest rates and I think that is very transparent of them.”
  • “The Fed is doing a good with job communicating monetary policy.”
  • “Sometimes I think the Federal Reserve’s communications are in a state of flux.”

This week’s Sentiment Survey results:

Bullish: 24.0%, down 0.8 points
Neutral: 38.9%, up 2.0 points
Bearish: 37.1%, down 1.2 points

Historical averages:

Bullish: 38.5%
Neutral: 31.0%
Bearish: 30.5%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!