John Tousley last week shared his crystal-ball view of 2017 with a Salt Lake City audience, and generally the outlook was positive.
The U.S. has a fundamentally strong economy and a lower-than-average risk of a recession in 2017, as well as expectations of steady GDP growth this year, the managing director and head of U.S. strategy for Goldman Sachs’ Strategic Advisor Solutions told the Salt Lake City Rotary Club.
This year also should see “easing” financial conditions, a bit of inflation, some wage growth, a Federal Reserve raising interest rates and more volatility in the equities markets, Tousley said.
“We are, in short, a very glass-half-full type of deal,” he said in describing the U.S. economy. “We are realistic about the opportunities. We have some headwinds in terms of valuation; policy uncertainty; political uncertainty, particularly in Europe with a really robust calendar. But at the end of the day, the fundamentals — the things that ultimately for us are most important, a lot of the underpinnings for investments — look pretty good.”
Still, data indicates that there is an elevated concern in the public. “We think the fundamentals are in pretty good shape but we know there is concern about the sustainability of the fundamentals,” Tousley said.
One reason for concern is the rationale that the recovery from the recession is now in its 89th month, while the average post-recession expansions lasted 72 months. So, that thinking dictates, the economy is due for a downturn. “That,” Tousley said, “is flawed economic logic” because age does not cause recessions. “Expansions in economies don’t die of old age,” he said.
Under typical conditions, the U.S. has an average of a 24 percent chance of a recession within a year. But the figure now is about 19 percent.
“Now, it’s just a model, but the key takeaway I want you to think about is, our recession risk is below long-term average,” Tousley said. “The fundamentals, what doesn’t necessarily capture the media, are pretty robust and the risk for a downturn in the next 12 months is lower than average. … When we look at the state of the consumer, when we look at the state of housing, what we’re seeing is an economy that is generally operating very well.”
Tousley predicts U.S. GDP growth to be 2.3 percent in 2017 and 2.2 percent in 2018. That outpaces 2016’s rate of 1.6 percent. At one time, 3 percent was considered optimal but now the optimal level is 1.8 percent, he said.
While the economy faces upside risks to due policy changes — tax reform and fiscal stimulus, for example — “at 2.3 [percent], that’s still slow and steady growth,” he said. “That is not explosive growth. That is not escape velocity.”
Financial conditions — a metric considering the dollar, stock market, interest rates and credit spreads — are easing, making growth a bit easier and “should be a tailwind to the economy,” he said. The nation is nearly at full employment, and wage growth should reach 3 percent to 3.5 percent, above the 2 percent average growth during the recovery.
The housing market is “generally OK,” he said. “Households are forming faster than we’re building houses. So even though the housing market has had a nice recovery, the homebuilding index is doing pretty well, single-family home starts are up 20 percent year over year, believe it or not, there’s still room to grow,” Tousley said.
And while the past few years have featured predictions of the Fed boosting interest rates, only to have them not materialize, 2017 should be different, he said. He predicts two or three increases during the year, each of 25 basis points, starting in June. He used the analogy of “popping the clutch” on a manual auto for the current Fed environment. A very conservative Fed has not wanted to pop the clutch because of concerns that the private sector was not ready for it and that doing so would create global issues.
The Fed in 2017 “will become comfortable popping the clutch” because the private sector has the capability to maintain the momentum. “And that’s a major shift and it’s been a long time in getting there,” Tousley said.
As for the equity markets, expect a different environment than in, say, 2013, when “you could buy anything” and “the worst idea was just fine” for getting a return. It was a “damn the torpedoes, full speed ahead” time, he said.
“There are times in battle, like there are times in investing, where unbridled risk-taking is the right strategy,” Tousley said. “This is not one of them.”
People should still invest in the markets but be more selective. “We think you’re going to make money in stocks — 5 to 7 percent — but you can’t just own things in a blanket way. You’ve got to be a little more prescriptive in how you’re investing,” he said.
Earnings growth, not multiple expansion, should be the primary driver of equity returns, he added.
“We believe we’ve entering a new period of volatility. The slope of your returns is going to flatten out a little bit. You’re still going to make money in equities, but the rate of return is … going to be dominated by earnings.”
Tousley urged equity investors to be patient because losses are a normal part of the environment. Even though 21 of the past 26 years have resulted in positive annual total returns, 19 of those 21 featured low return levels at one point or another.
“The range of outcomes [will be] much, much wider,” he predicted. “So it’s going to take more intestinal fortitude, more stamina, to stay in these markets. You’re going to get more volatility for less returns. It will be worth it, but only for the patient, disciplined investor.”
