The following release was prepared by Gaurav Ghantkar and Ajay Kaushik on behalf of the 2016 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.
The Henry Fund Research team’s October outlook reflects the tepid outlook for the US economy.
The recent job market report was underwhelming with only 156,000 jobs added for September, which was below the consensus forecast of 172,000. Our outlook for US employment is neutral for the near term with a more favorable outlook for the long term. The team predicts unemployment to remain near the current 4.9% level over the next six months and decreasing to 4.75% over the next 24 months. Additional job growth will continue to be partially offset by workers entering or returning to the labor force.
We expect real GDP growth will average approximately 1.8% over the next six months, down from our September consensus estimate of 2.0% growth. There has also been a downward adjustment to our longer-term real GDP growth forecast. The team continues to expect positive, but moderate growth of 2.0% through 2018. We do not anticipate the US economy entering a recession in the near term.
A strong dollar has made US exports more expensive for foreign customers, while fluctuating oil prices and rampant oversupply have debunked the theories of oil prices rebounding to record high levels. Meanwhile, the latest report issued by the Institute for Supply Management (ISM) indicated that manufacturing and service sector activity have expanded during the month of September as opposed to the contraction witnessed during August. The Purchasing Manager’s Index (PMI) came in at 51.5 that represents a slow but growing economy, which is reflected in the research team’s forecasts for the short term and long term GDP growth.
Henry Fund consensus estimates for interest rates remain largely unchanged through the election cycle. The team expects the Federal Reserve to begin gradually increasing the Fed Funds rate in December of 2016, but does not anticipate a large boost to market rates in the near term. We expect the 10-year Treasury bonds will rise to a 1.75% yield by Q2 2017. The 10-year term premium, i.e. the difference between short-term treasuries and the 10-year note, has been at its lowest levels since 1962. This situation is expected to improve slightly in the next 12 months, signifying a slight acceleration in economic growth. With a wider 10-year term premium, we believe that FOMC will raise the Fed Funds rate to 1.25% by Q3 2018.
The change in the Consumer Price Index (CPI) has hovered in the 0.7 – 1.4% range, despite the low interest rate environment. Low oil prices and falling commodity prices have been the major driver of the low inflationary environment. The team believes that the systemic oversupply of crude oil will continue through 2018 keeping the price of crude oil below the $60 dollar per barrel mark. The low oil prices coupled with the tepid GDP growth expectation in the next 6 -24 months will continue to fuel a low inflationary environment. We anticipate annualized inflation of 1.2% in the next six months and rising to 1.9% within two years. These forecasts reflect a slight upward revision compared to our August estimates.
Weak job numbers and concerns regarding the magnitude of impending interest rate hikes have driven our forecasts for consumer confidence, which has remained strong in 2016. We have a neutral outlook for the consumer confidence index over the next six months with a slightly stronger outlook by 2018.
We expect currency headwinds to continue for American companies as the dollar continues its surge relative to the euro. Exchange rates are projected at $1.10 per euro in six months and continue through to 2018 due to the continue struggles in Europe.
Finally, global trends, expectation of hikes in interest rates, and tepid GDP growth all filter down to our projections for the S&P 500. We anticipate US equities will trade relatively flat over the next six months. We are becoming increasingly concerned about current rich valuation levels in the market. With a median forward P/E of 14.64 for the S&P 500, the team has found it difficult to identify new investment opportunities across most economic sectors given high P/E levels across these economic sectors. However, going forward we like targeted investments in health care and information technology, especially in the areas such as the Internet of Things and cloud services.