2016 Economy

Memorial Day marks the beginning of Summer and the end of the first third of the year. At this time each year, I update my annual economic outlook for the year. I also take a quick look back at what I predicted early in the year to see how we are tracking with my forecast.

Due to the volatile events at the beginning of this year, I updated my January forecast in late February. At that time, I said the following:

“The fear of deflation on a world basis is what is causing bond prices to continue to rise and central banks to keep interest rates at next to zero. These concerns will cause the US Federal Reserve to postpone additional short term interest rate increases until at least late 2016 and probably until 2017.

As a result of these factors, I expect the US stock market to be at slightly higher levels by the end of the year. Specifically, I expect the US market as defined by the Dow Jones Industrial Average to trade between 15,500 and 18,000 and close the year between 17,000 and 17,500.

Bonds will continue to rally into the second quarter and then back off slightly and close the year about where they were at the end of 2015.From now until the end of the year, the return on bonds will trail the return on quality stocks with high dividends.”

After a second low at 15,503 on February 11th, about a week before the above prediction, the Dow rose to a peak of 18,168 in late April. Earnings disappointments caused a reaction to 17,339 two weeks ago until a rally last week to 17,892. We are now at the top end of the range I predicted at the end of 2015.

The US market, and to a lesser extent all world markets, are being driven by the continuation of low interest rate policies by central banks around the world. Short-term interest rates in some European countries are negative for short-term loans. Even this bizarre monetary policy has not stimulated significant economic growth in the world economy.

As long as the central banks are willing to print money, investors seem content to put more and more money in the stock market despite expansion of earnings multiples and forecasts of slower earnings growth.

I expect stock prices to continue to be strong with periodic interruptions due to short-term world crises or major earnings disappointments. Until we actually get a recession, which is very unlikely in an election year in the US, there is little risk of a major stock market decline. In fact, short term reactions like we had in the first half of May can be a good opportunity to add to positions.

I now expect the stock market as defined by the Dow, to trade between 16,300 and 18,500 for the rest of 2016. At the end of the year, the market should be within 5% of the current level. Try to invest in stocks with good earnings, and dividends if possible, when we the have a short-term correction.

Don’t be surprised by the periodic short-term drops. One of these could come in late June when the United Kingdom has an election scheduled to vote on whether or not to leave the Economic Union. A vote to leave the EU would likely cause a short-term recession in Great Britain.

The reason for this vote hints at one of the threats to the world economy and to peace in the world in general. It is the influx of Middle Eastern refugees into Europe and the globalization of evil Islamic Radicalism. The result of Obama ignoring this threat for the last seven years is that the terrorist organizations have been able to establish cells of terrorists around the world. This threat has increased with the volume of refugees pouring out of the Middle East. There are so many refugees that no country can adequately vet those who want asylum in their country.

This issue, and its long term effects on the European economy, are at the core of the proposal for Britain to leave the EU. Britain does not want to subsidize the cost of the refugees in Europe. The terrorist events in Belgium and France in the last year were predictable given that there are areas in most European countries that are heavily populated by Middle Eastern immigrants. Most of the time, police will not even enter these areas. Maintaining peace in these countries is likely to become more and more difficult over the next few years.

US and world economic growth remains positive but slow. Inflation and interest rates remain low, although any sustained increase in economic growth would likely stimulate unwanted inflation. Risks of a recession are slim, and I do not expect an interest rate hike until the end of the year, if at all.

The challenge is the long-term. If we do slip into a recession at some point, there will be little the Fed can do to fight it since interest rates are already extremely low. A prolonged recession brings the risk of worldwide deflation and a depression. This is the ultimate fear of the world’s economic leaders.

On the flip side, strong economic growth will cause inflation. This would cause interest rates to rise. And this could quickly make repayment of US debt extremely difficult.

Donald Trump has proposed refinancing much of the US debt with longer term debt. Such debt would have terms as long as 100 years as well as higher interest rates. This move would save the US interest expense long-term despite higher short-term cost in the almost certainty that interest rates will rise at some point.

Mention of Trump brings us to the election. As I indicated at the beginning of the year, the Trump candidacy was real. I suggested that he has started a movement and that he had initiated the end of the Republican Party that has been in place since 1980.

The events of the last few months have validated this view.

Most of the Republican Party seems to be rallying around Trump despite all there is to dislike about him. His mix of practical conservatism and taking on political correctness has given him the possibility of being elected president. His version of the Republican Party is populists and not elitist. This is at the core of the lack of support for him by Republican leaders. Traditional Republicans are well-entrenched in Washington and in the governmental albatross. A candidate such as Trump who threatens this status quo is going to be resisted because traditional Republicans will put their self-interests before the desires of the public.

Would Trump be a good president? I do not know. Should we fear that he will do something crazy as president? I don’t think so.

Why? All presidents seem to moderate their actions once they are elected. I suspect a combination of what they are told in the first few weeks after they are elected about what is really going on and the gravitas of being President tend to quickly curtail some of their more aggressive ideas before they are inaugurated.

This moderation of campaign positions is less likely with Hillary Clinton than with Trump. She is a Washington insider and will clearly keep most of the policies of Obama. My frustration with her campaign is that if is she was not a Clinton, it is unlikely she could get the nomination. Her track record in terms of integrity and with regard to policies and actions as Secretary of State would preclude her running for president if not for the connection to Bill Clinton.

Whatever the result, this election will be one of the most entertaining in history. It will be based more on attacking the other candidate than on vetting out the policies of each candidate. Never in our history have two people with such high negative ratings run for president.

My expectation at this point is that Hillary Clinton will be the next President of the United States. She will win primarily because of the huge advantage the Democratic party has in national elections. She will also benefit from Trump’s inability to get support from some of the wealthy conservative elitists who, based on their actions, prefer Hillary Clinton.

Clinton’s election will be good for the stock market in the short-term, but it will also continue the increasing role of government in every aspect of our lives. It will lead to more and more people who do not work being taken care of by a shrinking middle class. As we become more like Europe, our country will become less great and will likely exert less leadership in the world. Ultimately, it will cause serious economic problems for us, and especially for our children and their children.