The following release was prepared by Michael Emgarten and Catherine Carlson on behalf of the 2014 Henry Fund research team. The team updates its economic outlook several times throughout each semester. This analysis forms the basis for class discussions, company selection, and investment research.
On Sept. 26th, real GDP growth in the U.S. was revised upwards to 4.6% for Q2 2014, from an initial estimate of 4.2%. The economy is regaining traction as consumer confidence strengthens and business sector spending accelerates. We forecast real GDP growth of 2.7% in Q3 as the economy decelerates from a strong second quarter.
The Consumer Price Index (CPI) for urban consumers decreased 0.2 percent in August, making it the first decline since April 2013. Food and shelter indexes rose 2.7%, but were offset by declines in energy, particularly gasoline prices. Over the prior 12 months, U.S. inflation, measured by the change in the CPI, has grown at 1.7%. We expect inflation will remain around 1.75% over the next six months, increasing to 2.0% for our two-year forecast.
The US unemployment rate was measured at 5.9% in September, a decline from the previously reported rate of 6.1% and a post-recession low. However, we have not seen an increase in job wages, and we believe that the drop in unemployment is partially driven by a decline in the labor force participation rate. It was reported last month that an additional 97,000 people dropped out of the labor force. While historical consensus defines a healthy unemployment rate around 5.0%, we believe that this level is too low under current economic conditions. Going forward, we expect the U.S. unemployment rate will increase slightly to 6.0% over the next six months, with a two-year outlook staying around 5.90%.
With a flight to quality in the market over the last couple of weeks, the 1-year and 10-year T-Bill yields have fallen even lower to 0.11% and 2.18%, respectively. Despite the Fed’s continuation of exceptionally low interest rates, we see rates drifting upwards over the near term, with 10-year yields rising to 3.50% within two years. The Fed has remained very cautious about raising rates so far, despite generally positive economic indicators, and we feel that rates will begin to rise within the next 6 months.
WTI Oil prices are down nearly 20% from their summer high to just over $85 a barrel, due primarily to a glut in supply. We are not entirely surprised by declining oil prices because of the growth in North American shale production, but we are concerned about the momentum of the price declines. In addition, Saudi Arabia’s recent actions seem to indicate that it is not interested in reducing output in order to stabilize prices. Given the continued turmoil in Iraq and sanctions on major producers in Russia, we would not have expected prices to fall as much as they have and we wonder if recent downward revisions to global GDP growth is effecting global demand estimates. Despite the recent developments, we forecast WTI prices to return to $90 within the next 6 months and return to $100 per barrel within the next 2 years. A significant percentage of the Henry Fund’s holdings are concentrated in the North American shale industry or services supporting continued growth in shale production and continued price declines would have a material impact on the team’s strategy going forward.
The Consumer Confidence Index fell from 92.4 to 86 in September, a move that coincided with a decline in home and automotive sales and much greater volatility in the U.S. equities markets. The VIX recently topped 25 for the first time since 2012, and the S&P 500 experienced some of the largest single day declines in the past 3 years. We have been concerned that increases in corporate profits have been driven more by artificially low interest rates and unsustainable levels of corporate tax breaks than by actual increases in operational profitability. Although we believe that a modest correction in the market may have been overdue and that we may continue to see increased volatility in the market for the next couple of months, we still maintain our forecast that the S&P 500 will grow at a modest pace to 2050 over the next 2 years.