Today’s Headlines: CEOs, Fed: Economy Lacks Momentum

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Today’s Headlines: CEOs, Fed: Economy Lacks Momentum
March 22, 2016

CEOs See Little Economic Momentum

Economists give us a broader view of America's economic condition, but to get the view from the trenches, seek the opinion of corporate CEOs. After all, they’re on the front lines of sales forecasts, hiring expectations, and other economic drivers.

What do America’s corporate honchos expect for the near future? According to the Q1 CEO Economic Outlook Survey released by the Business Roundtable, CEOs have mixed expectations on America's economic outlook, but agree that the economy is growing at a rate below its potential.

Their expectations for hiring and overall economic growth in 2016 are declining. CEOs now expect the economy to grow at 2.2% in 2016 instead of the 2.4% predicted in the previous quarter. Only 29% of CEOs expect to increase employment over the next six months, down from 35% in Q4 of 2015. Worse yet, 38% expect to decrease employment, up from 34% in Q4 of 2015.

The message is not entirely gloomy, however. A greater percentage of CEOs expect to increase capital spending over the next 6 months (from 30% to 34%), and the overall Economic Outlook Index rose to 69.4 from 67.5 in Q4.

Put simply, CEOs believe the economy can do better, but feel we are still on a steady growth path that warrants a likely increase in capital investment. In other words, slow growth is better than no growth at all.

We Can Do Better Through Trade

How would CEOs improve growth? Business-friendly government actions could help, starting with Congressional ratification of the Trans-Pacific Partnership (TPP). The recently negotiated TPP is a major trade deal involving the U.S. and 11 other countries throughout the Americas and the Pacific Rim, covering 40% of the world's economy. A majority of CEO respondents said the TPP would allow their companies to become more competitive globally, thus allowing the companies to grow and expand U.S. operations.

That sentiment is falling on deaf ears in an odd political year with hardcore populist movements on both sides of the political spectrum. Given Bernie Sanders' railing against "disastrous trade deals," Hillary Clinton's leftward drift on trade policy (spurred by her competition with Sanders), and Donald Trump's assertions that we are "getting killed" on trade with China and other nations; CEOs are leery about the odds of a more business-friendly administration.

A different CEO survey provides a bit more insight. Chief Executive magazine compiles a monthly rating on CEO forecasting of the economy twelve months into the future. Their survey also shows an uptick in expected economic health with a reading of 6.04 out of 10, breaking a year's worth of decreasing ratings. However, the variation is large, depending on expectations for the November election.

It's no great surprise that CEO forecasts hinge on election results. In the words of one respondent, a Republican victory warrants a "good" forecast while a Hillary Clinton victory warrants a change to "weak" (and presumably equal or worse with a President Sanders).

While Trump has said, "TPP is a horrible deal," he is a CEO as well as a candidate — and thus CEOs seem to expect a business-friendly environment under President Trump. Perhaps they expect him to negotiate a better deal than TPP.

The Fed Agrees on Growth Projections

The Federal Reserve has reached a similar conclusion to the CEOs with respect to growth. The Fed foresees an annual economic growth rate of around 2.2% for 2016. After raising interest rates in December by 0.25%, the Fed implied that the benchmark rate would increase by 1% in 2016. That forecast was changed at last week's Fed meeting to 0.5%, likely with two increases of 0.25% assuming that the slow growth pattern continues.

Given the first quarter results in the stock market, a shift in Fed strategy was expected. The arrival of 2016 initiated Wall Street's worst start ever to a year. The Dow started the year at 17,425 and dropped to just below 10% of its starting value on February 11 before rebounding. With the Fed's announcement, the Dow rally picked up speed and surpassed 17,425 the next day.

Even With Low Economic Momentum, Stocks Rise

The economy may not have much momentum at the moment, but stocks are enjoying a sustained surge. Markets have recovered from a horrid start in a relatively short time. The Dow has gone positive for the year and the S&P 500 reached positive territory on Friday. The NASDAQ is lagging behind at a net 4% loss for the year, but it is also recovering — just at a slower rate.

This comeback reinforces an important point: the economy and the stock market are two different beasts. The economy is based on objective numbers such as GDP, inflation and unemployment rates, while the stock market reflects tangible value, perceived value and expected future value, as well as emotional and psychological factors that are highly subjective

CEOs understand these differences and must interpret economic psychology alongside the measurable numbers in their market sector. It seems a majority of CEOs are concluding that both the psychological and tangible factors are favorable, and are leaning toward optimism. However, that optimism is fragile and subject to unpleasant economic or political surprises.

The Takeaway

CEOs are looking at a host of mixed signals that indicate relatively slow economic growth with no significant momentum. The Fed has similar concerns about sustained growth and is managing interest rates carefully to avoid stalling out the growth we do have. Their collective attitude is best captured by the phrase "cautious optimism." At the moment, the domestic equity markets seem to be buying into this optimism and are propelling stocks forward.

MoneyTips remains cautiously optimistic also, but please underline the word cautiously.

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