Although global growth will slow in the coming year, what is already the longest expansion ever will continue, according to David Kelly, chief global strategist and head of the Global Market Insights Strategy Team for J.P. Morgan Asset Management. Kelly was a principal speaker at Investments & Wealth Institute’s recent Investment Advisor Forum.
“I’ve called the economy a healthy tortoise for years,” said Kelly. “Growth ambled forward at 2.3 percent annually.” And he expects that to continue.
In the last year, the U.S. economy has been on a huge shot of caffeine because of the tax cuts, Kelly said. This year, it’s going to be a bit of a “decaffeinated economy” as the effects of the tax cut fade. If corporations had been investing, growth would have been more sustained, he said. But, the tax cut provided a “sugar rush” fueled by consumer spending, and growth in consumer spending is slowing down.
While Kelly said he expects a slowdown, he does not expect a recession. That’s because there appears to be nothing looming to precipitate it.
“Expansions don’t die of old age,” he said. Normally, the economy contracts because one of the major economic engines slows – homebuilding, capital spending, or car buying – or inventories rise. But, because growth in these cyclical sectors is already subdued, there will be no boom, or bust, he said.
The slowing of growth will be gradual rather than precipitous – a “soft landing” – also in part because the Federal Reserve appears to have adjusted its rate hike plans in response to slower growth. Whereas the Fed had projected raising rates at least twice in 2019, it not seems that there may be no rate hikes in 2019, Kelly said.
“Volatility, lower inflation, and lower asset prices may cause the Fed not to raise rates at all this year,” he said.
With relatively low oil prices and slow wage growth, inflation is likely to remain subdued, Kelly said. He expects inflation to “drift down,” then gradually return to around 2 percent. Unemployment will continue to fall, but more slowly than it has been, possibly getting down to 3.2 percent, he predicted. He noted that employment data are lagging economic indicators, and that any report of job growth actually reflects the strength of the economy several months earlier.
Risks to a continuation of the “healthy tortoise” economy include trade tensions, greater than expected weakness in global economies, and Washington instability, Kelly said.
Neither tariffs nor a trade deal will fix the U.S.’s trade deficit and tariffs are “sand in the global economy,” he said. Tariffs hurt the rest of the world more than the U.S. initially, but they eventually will be more harmful to the U.S. than they already are.
The U.S.’s trade deficit cannot be fixed with tariffs or trade deals because the trade deficit is a result of the budget deficit, Kelly said. If the U.S. reduces its trade deficit with China, a deficit will pop up with another country. The U.S. does, however, need a long-term strategy to address the fact that some countries are stealing its technology secrets, he said.
The combination of slower growth in the U.S. and its large trade deficit will tend to push down the value of the dollar, which appears to be overvalued, he said.
In the current environment, Kelly said he would “be a buyer” of U.S. and international stocks and would underweight fixed income. U.S. stocks are relatively cheap as a result of the selloff in the fourth quarter of 2018. Investors should not be put off because earnings growth forecasts for the first quarter of 2019 are lower than they have been. Earnings growth was “spectacular” in 2018 and the projected slowdown is in part a result of the government shutdown at the beginning of the year, he said.
“That doesn’t mean stocks are a bad idea,” Kelly said. “The level of earnings makes stocks look like they are reasonably priced in the U.S.”
It is also a “great time” to increase one’s international investments, he said. Most people are wary of international stocks, but they should not be, he said. U.S. companies represent 56 percent of global capitalization and their share in a portfolio should not exceed 50 percent, he said. Kelly favors emerging market stocks, then European, then Japanese.
With respect to fixed-income investments, Kelly observed that returns of 2.4 percent are not very attractive and that there are “slender pickings” in the asset class.
While trade tensions, slower than anticipated global growth, and upheaval in Washington pose risks, Kelly said the biggest global risk of all is the decline of democracy.
“Dictators are bad managers of economies,” he said. The inequality in the distribution of wealth is also a major risk because it reduces demand, he said.
