After experiencing a small recovery growth from 1.7% to 2.6% in the year 2013 – 2014, the US economy showed relatively stronger growth in 2015 with a real GDP of 2.9%. The first half of 2015 was moving strong with an average GDP growth of 2.95% but unfortunately the US economy could not find support at this level and the growth fell to an average of 1.05% in the later part of the year. What felt like a strong start for the US economy eventually turned into a disappointment.
After looking at the various factors which influenced the US economy in 2015 – consumption, investments, net trade and government spending, seems like personal consumption expenditure (60-70%) had the most positive impact out of all on the GDP growth. The personal consumption expenditure showed strong growth of 3.7% in the first quarter of 2015, however it relatively declined in the rest of the year but closed at an average increase of 3.6% compared to the 2.9% in 2014. In fact, 2015 experienced the highest personal consumption expenditure growth since 20051. Consumption of durable goods took a steep growth of 7.7 % which was one of the most important factors why the overall personal consumption expenditure went up. The personal consumption expense greatly depends on how confident the citizens are feeling towards the market. Compared to the last 10 years, the consumer confidence hit an all-time high of 101.4 in early 20152. The US citizens were spending more which shows increased consumer confidence but the confidence started to decrease in the later part of the year and hence the personal consumption expense dropped too. An important reason for the increase in overall personal consumption expenditure was the decrease of oil prices. Oil prices decreased drastically in 2014 and 2015 because US started drilling and became the largest producer of oil3. Due to high supply, but not too much demand the price of oil lowered drastically. Though US had driven down OPEC’s global market from 60% to 40%, this did not stop OPEC from decreasing their supply in fact they are producing even more now4. Due to the low prices, consumers and industries used more oil which is one of the factor in driving up consumption. According to the website SSA.gov, the average wage index went up by 2.4% in 2015 against 2014 which gave consumer relatively more income and free cash to spend which in turn affects the consumption5. Another occasion that fortified purchasing power was diminishing of different monetary standards of euro, yuan or yen, with respect to the US dollar.
Though the gross private domestic investment of US fell from 5.5% to 5.2%, it was the second most influential factor in the rise of GDP in 2015. The residential sector experienced a considerate hike in 2015 as the housing market experienced a 14% growth in sales which was the highest since 2007. The Fed was planning on increasing the interest rates very soon, which made a lot of people dive into the residential market because they could take the advantage of the low interest rates currently with no inflation. Because the purchasing power had increased and people had more confidence and the good economy signs made a lot of people invest in residential fixed investments and real estate so that they could earn a good return, whereas nonresidential fixed investments and private inventory investment contributed negatively to the growth.
As the US has always been a net importer rather than an exporter, the numbers which contribute to the US GDP from net trade is in most cases negative i.e. the net trade of US contributes negatively to the US economy. An important factor which affects net trade is the US dollar value against other currencies. As stated earlier since the dollar value was becoming stronger against other currencies and oil was cheaper, it was cheaper for the US to import goods and services in 2015. Due to this reason, the US saw a growth of 5% on imports in 20156. Whereas the exports suffered drastically from 4.3% in 2014 to 0.4% in 2015. As we know due to the strengthening of the dollar, exports decreased in number because for the same amount of money spent, now people importing goods/services from foreign countries are receiving less number of goods/services from the US.
The government expenditure had grown by 1.4% in 2015 which was better when compared to the -0.6% growth in 2014. According to the US Treasury Department, the US deficit had fallen substantially to $439 billion in 20157. The main reason for the deficit to fall was largely due to the increase in revenue, a result of the economy recovering, decrease in defense spending and growth in other parts of economy. Though the deficit had fallen, the debt of the public was on a constant rise from $5 trillion in 2007 to $13 trillion in 2015 and is expected to rise drastically in the coming years8.
The stock market in 2015, was rather dull/flat. The Technology industry did well and NASDAQ outperformed S 500 and Dow with a considerate margin. The bond market performed decent too, but the high yield bonds were bearish and took a huge loss obviously because the stock market was not too bullish.
As the last quarter of 2015 showed weakness in the economy, the year 2016 started out weak, slowly gained momentum in the mid-year and slowed down again in the later part of the year showing a parabolic like trend in GDP. After looking at the graph below seems like the most powerful and consistent factor which positively contributed to the economy in 2016 was consumption rate which outperformed the actual GDP rate in the year. Whereas the weakness in the economy came from the negative contributions from investments and net trade. There were number of factors contributing to the economic condition in 2016 which I will explain in detail –
The main strength of the economy in 2016 came from consumption which finished with a 2.7% increase since 2015. As I have mentioned in the 2015 section, a lot of the contribution to consumption came in from the boom in residential and automobile sector. There was also an increase in healthcare expenditure due to the increased healthcare insurance rates9. Since the dollar strengthened against other currencies and due to low oil prices, people bought a lot of cars like BMW, Mercedes, Ford, Porsche etc. As the job market grew and more jobs were created, there was low unemployment rate in the country and better wage growth. The Fed had only raised the interest rates once in the year and low inflation caused more confidence among the people. Due to these factors the consumer confidence started to rise after the first quarter and people had more disposable income in their hand which led more spending on goods and services. 10
There were several factors which also hindered the growth of consumption in 2016. Some of the factors include Terrorist attacks, Brexit, presidential election. There was a major terrorist attack planned by ISIS in Orlando on July 12th, 2016 which killed 49 and many wounded people in a nightclub11. Terrorism has more impact on economic growth than most of us would expect. All kinds of markets hate uncertainty and terrorism creates a lot of uncertainty. Three obvious industries vulnerable to effects of terrorism are insurance, tourism, foreign direct investment etc. Terrorism also causes increased nationalism and foreign skepticism. Brexit was another factor which hindered the rate of consumption. Though trade between UK and USA makes up just 1% of US economic activity, the connections go beyond just direct trade12. Americans make up majority of the US economic activity. If the people don’t spend, then the economy will slow down. The extent to how much they spend largely depends on how good they feel about where the country is heading. Uncertainty in the marketplace brings down the confidence. Brexit caused volatility in global stock markets and the number of jobs created has slowed down. Brexit also triggers the dollar value to rise against other economies. The US dollar value saw a sudden growth of 6.3% against the British pound, which is the biggest one day gain since 196713. This is bad in once aspect because, the companies which sell their products overseas would be at a loss because products which were being exported were less attractive to foreigners. Therefore, this lowered the US exports which intern hurt the GDP.
Compared to 2015, investments were very weak in 2016. Investments did not perform well in the first half of the year, but we saw a little movement in the later part of 2016. overall, investments contributed negatively to the economy with a -1.6% growth rate.
Due to the presidential election which would be conducted in November 2016, there was a lot of uncertainty and doubt among companies. Many MNC’s pulled back from spending money on constructing new buildings, facilities, equipment because they wanted to wait and see how the new tax bill will affect their business. Companies typically invest more when they feel confident about the economy is improving, and this downturn in capital spending shows us weakness in the economy. Large multinational companies saw a decrease in corporate earnings since the dollar was still stronger compared to other currencies and their products were still more expansive
The prices of crude oil increased in 2016, but were still below the 2015 average price. Despite the demand for petroleum products, the high supply levels provided downward pressure on oil prices to an average selling price of $43/barrel in 2016 but the price saw an increase in the later part of the year. According to US Energy Information Administration “Recent agreements to curb production over the next six months within the Organization of the Petroleum Exporting Countries (OPEC) and additional pledges by some key non-OPEC producers put upward pressure on prices at the end of 2016 as markets appear to be anticipating tighter balances than previously forecast14” The 2016 corporate default count climbed to 136 issuers out of which half of them were oil and gas companies. These factors drastically contributed to the negative contribution to investments15.
Amazon due to its competitive advantage in e-commerce, killed a lot of big box stores by cutting costs down costs drastically and driving out the competition.
Real estate market did well in the first quarter of the year, slowed down in the mid and slowly gained momentum in the later part of 2016. There were 4 months’ supply of homes on the market whereas in 2006 there were 12.5 months of supply. This shows that the real estate market was on the rise and the market was tight i.e. the demand was growing. Due to the growth in the demand the prices started to rise and the economy was looking better. The demand was greater than supply. People wanted to buy homes but homebuilders could not keep up with the demand. and the interest rates were rising and therefore the mortgage rates went up.
In the first quarter of 2016, the residential investment accounted for roughly half of the 1.1% increase in real GDP. Homebuilders decided to target wealthy people and started building luxury homes rather than targeting middle class because middle class incomes have been declining since a long time now. Also, mortgage financing companies were not too open to lending unless the clients were very credit worthy borrowers. Whereas new homebuyers were forced into renting house because of lack of credit, as a result driving up rents.
Due to the stronger dollar after Brexit, exportation of American goods got affected because it costs more now for foreigners to purchase the same goods/services. After Uk voted to leave European Union the US dollar value saw a sudden growth of 6.3% against the British pound, which is the biggest one day gain since 1967. The European Union was the largest trading bloc’s and its major partners were US and China. And due to Brexit, a lot of uncertainty arised and UK would have to renegotiate trade deals with the US16. Due to this reason investors in trade would play a cautious waiting game to see the results of the restructuring. This might be the reason why the export oriented businesses slowed down in 2016.
On the flipside, the direct impact of stronger dollar value is that people in the US can import more goods and services for the same price. Whereas the indirect impact of the strengthening of dollar value is that when a foreign exporter of US dollar priced US imports gets more of the foreign currency in return for the item priced in dollars and adjusts the dollar price to be more competitive to the US purchaser. Due to this US importer experienced even lower dollar prices while exporters were still able to get more of their own currency because of the increased purchasing power of dollar17. This stopped the imports from growing more than what they did in 2016.
The Federal reserve raised interest rates by 25 basis points for the first time in December 201618. This is good news to the economy and shows the Fed’s confidence in the improving economy. And the unemployment raised has fallen to 4.6% which shows that the US economy is ready for a steady growth. The increase in interest rates by the fed took the steam out of the stock market bull rally that was hoping to grow even faster due to the Trump’s administration plans to cut taxes, boost spending and cut regulations. The possible increase of moderate interest rates by Fed can be looked as an effort to not to move too fast as this would risk the economy to go into recession, and not move too slow which would lead to the overheating of economy and inflation to rise.
Overall it was a pretty good year for the stock market in the fiscal year 2016. The stock market started off the year slowly in the first quarter of 2016 and had seen a lot of volatility. 2016 volatility reached a five-month high with the VIX index trading at 28. It had fallen below 14, the lowest since 2015. The high volatility in early 2016 was driven mainly by commodities because oil price continued to collapse and oil producing countries felt the strain. The S&P 500 had outperformed NASDAQ in 2016. The low performance of stock market in q1 can be a result of commodities and stronger dollar value. But the stock market gained traction and ended up being a good year for stockholders. The Dow finished up 13.42% while S&P 500 narrowly missed out the double-digit gains in the end of 2016. The Nasdaq ended with a net gain of 7.5%. The biggest winners of stock market were the Energy sector with 23.65%% growth and financials up by 20.14%. Some other noteworthy sectors were telecom up by 17% whereas healthcare went negative by 4.36%19.
The bond market did well too surprisingly. The 10 year YTM increased to 2.45% and 30 year to 3.68%. As people were confident and had more disposable income in their hands, they invested both in stock market and bond market. Both the stocks and bonds performed relatively better than last year. The high yield bond market did extraordinarily well because of the positive correlation between high yield bonds and stocks. What stopped the bond market from doing even better was increasing interest rates and the rising inflation expectations in the economy. This pattern showed even more effect after Trumps’ presidential election20. People were expecting trump to boost the economy, giving it growth and inflation that has been lacking since the recession. Due to this people were expecting more growth and inflation, the bond market saw some resistance. Overall the stock and bond market seemed to have been going in the same direction rather than being negatively correlated, but stock market was the place to be in, this year.
The first few months of US economy in 2017 were sluggish but it started seeing strong growth (3%) from the second quarter and it has only been growing since then. President Trump had promised that he would get the economic growth for an entire year up by 3 %, but looking at the first nine months seems like we are still at 2.5% which is still very bullish. The third quarter showed a growth of 3.2% which has been the highest for three years21. Though we have a little sluggish wage growth and productivity growth, the unemployment rate is as low as 4.1% and jobs are being added at a considerate pace22. The economy seems to be on a very sound footing and the overall growth seems to be bullish in the future.
Two thirds of consumer spending were spent on services such as housing, transportation, recreation, hotels and healthcare and one quarter is spent on non-durable goods like food, energy, gasoline and clothes. The rest was spent on durable goods consisting of automobiles, furniture etc.
Though the consumer spending has been fluctuating a little bit since the three years, it has been consistent between a healthy 2-3% growth rate. Americans are saving less and spending more each year on various luxury items like automobiles, furniture, music systems etc.23 This shows that the consumers are more confident and optimistic now and have more disposable income due to a personal income rise than last year which is giving the consumption a little push to grow further. Due to this the retail business has been phenomenal in 2017. The online retail stores have seen a steep uptrend while the instore retails are seeing a downtrend. Also the Tax Cuts and Jobs Act represents the largest reduction in corporate tax in US history from 35% to 21%24. This gives the small business owners, middle class and the wealthy a lot of tax savings, which ultimately they will either spend or invest back in the market. Due to the tax bill large corporations like Apple, AT&T, Bank of America, FedEx, PNC, Starbucks and many more. This will give a lot of free disposable cash in the hands of the individuals which will eventually boost the GDP through higher consumption expenditure, confidence and investments. Consumer Confidence is supported by low oil price, the record-breaking stock market and the continued strength of labor-market conditions. All these things affected consumption to grow and it also shows that consumers believe that economy is moving at the right direction, because of it FED increased interest rates one more time for 25bps25. Though the spending has gone up this year, the savings rate has dropped lower than what was before the great depression which may be worrying in the future. After many years of deflation, the inflation is finally coming back in 2017 sitting at an average of 2.13% but the wage adjustments for inflation dust not seem to be happening at the same rate. Overall the consumption expenditure has helped the economy and looks like it is on an upward trend due to these factors but unhealthy spending can be dangerous but does not seems to be happening.
Investments seemed to be on the low side in early 2017, but the later part shows an upward trend. More investments were driven after the presidential election and Trump’s victory. Corporations were happy and were confident due to his victory and started investing. Trump promised that he is bringing back a lot of US based companies who were outsourcing for cheaper labor back to the US, so that these companies invest in the us and there can be more jobs created. The non-residential fixed investments and structures saw an uptrend in 2017, as a lot of companies and industries started building new factories and manufacturing facilities due to the increased confidence in the economy. The residential investments saw a sluggish trend, and there was more shortage in homes than in 2016. This shows that the there is more opportunity for growth in the coming year. Manufacturing of durable goods like automobile are doing great and seeing an uptrend. Manufacturing makes up 1/3 of the GDP and the capacity utilization in 2017 is sitting around 75. Which means that there is still a lot of scope for investment and improvement in this sector. With rapid increase in technology we can produce goods for a lower price now, and with Trump’s effort in bringing back outsourcing revenue back to the US, there is a lot of scope for improvement in manufacturing sector. However, 80 is considered maximum capacity and as we are nearing the 80 mark, this is an indication of inflation due to overheating.
In 2017, the exports saw a decent growth(5.3%) due to the weakening of dollar against other currencies. After the French election, the euro rallied to a six-month high against the US dollar in Far East trading.26. The dollar’s strength also weakened due to the delay in passing the healthcare and tax cut reforms till the end of the year. Another factor could be the delay in Trump’s promise of spending 1 million dollars on American infrastructure to grow the economy. The foreign policy announcement about North Korea and investigation about the Russian ties have reduced the investor confidence considerably. Natural disasters like Harvey in Texas and Irma in Florida had a negative effect on the economy due to unemployment and inflation. On the other hand, the imports are up by 6.5%, due to this America was running on a higher trade deficit than 2016. Also, due to the tax bill the US deficit will only increase more. The US imports electronics, equipment and clothes from China. A lot of imports are from US manufacturers that send materials to China for low cost manufacturing and labor. Once the goods are finished, the finished goods are sent back to US, which are considered imports27. Due to this, the trade deficit is only growing every year. As a result, a lot of manufacturing jobs in US are lost. President Trump wants to implement trade protection policies, which will make US consumers pay more for ‘made in America’ goods28
The Fed raised interest rates three times this year which shows an improving economy and stronger labor market. There have been a lot of jobs being added due to which the unemployment rate is sitting at lower than 4.1%. Inflation has also remained below the Fed’s target 2%, which maybe a little worrisome29.
This year was phenomenal for the stock market with record highs. S%P 500 and NASDAQ had their best years since 2013. S&p 500 jumped 19% and NASDAQ jumped by 28% this year. The Dow raced the highest with a record breaking 26000 in December. The biggest result of the success in stock market is due to the resurgent economic growth, tax cuts, consumer confidence and high corporate profits. The increase in interest rates by Fed also helped the earnings of stockholders to boost. The European Central Bank and Japan used negative interest rates this year to help stabilize their economies suffering from low inflation and help weak growth. Clearly this is an incentive to make people spend more.
The current Federal fund’s rate is 1.5%. Though the fed raised interest rates thrice this year, it did not stop companies from borrowing more. Due to more borrowing and more corporate earnings and tax cuts, almost every sector in the economy has benefited in the US.
The 10-year treasury rate is sitting at 2.4%. The US treasury bonds returned 8.5% this year which is very high. High yield bonds did great too this year (7.5%) because the stock market did well too and both are positively correlated.