The Week Ahead – Great Expectations

Welcome to “The Week Ahead” where we take a moment to provide our thoughts on what we can expect in markets and the economy during the upcoming week.

Last weekend I took my kids to see the new Lego Movie, “The Second Part”. While it was very good and everyone definitely enjoyed it, I couldn’t help but feel a little let down. You see, the original Lego Movie was such a positive surprise that the sequel was doomed to be a relative disappointment. It is human nature to have preconceived expectations informed by recent history. In the field of behavioral finance this is called recency bias. Simply put, if expectations are not met or exceeded, disappointment is inevitable.

Of course, this condition is not confined to movies. Recency bias colors all aspects of our lives, especially within financial markets. Oftentimes we see positive data, but because it wasn’t as good as was forecast, the result is a sell-off. Ironically, there are times when strong economic data can be bad for markets as it can be inferred that higher interest rates are looming. One of the main concerns of investors is that central banks (Federal Reserve, European Central Bank, Bank of Japan, etc.) will overly tighten monetary conditions thereby choking off growth to the point of recession. When volatility spiked in the fourth quarter last year, the Federal Reserve backed off its program of rate hikes sparking the strongest quarterly rally in the stock market more than 20 years. We now see that the odds favor no increase in the overnight Fed Funds rate and the market is predicting a 37% chance of a rate cut early next year.

Many of the key economic indicators being released this week have been strong:

• Trade deficit has been widening due to U.S. strength relative to the rest of the world (more imports vs. exports)
• Consumer confidence & sentiment are at all-time highs
• Inflation remains below target keeping the Federal Reserve at bay
• Chicago Purchasing Manager Index (PMI) is well within expansion territory

The U.S. economy grew at 3.1% last year, a number significantly above trend and the highest in this post-crisis expansion. Investors may be disappointed by the possibility of slower growth going forward. Indeed, the Federal Reserve Bank of Atlanta GDPNow model estimate for GDP growth in the first quarter of 2019 is just 0.4%. Some prominent economists are forecasting that the effects from the government shutdown may even cause this number to be negative. We believe that while the 1^st quarter may be disheartening, the effects from the government shutdown were transitory and economic growth will rebound resulting in GDP growth of 2.4% for 2019, which, while not a positive surprise, is still very good.

Data deck for March 25-March 29: