Tag: Research Affiliates

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First Quarter Economic Reports

The US Department of Commerce – Bureau of Economic Analysis (BEA) released its GDP preliminary figures for the first calendar quarter.  Real (after inflation) gross domestic product (GDP) increased at an annual rate of 2.0 percent compared to the prior quarter.

Personal consumption increased at an annual rate of 1.6%, while gross private domestic investment increased at a rate of 8.7%.  Nonresidential structures and residential structures both declined at rates of -6.7% and -8.0%, respectively.  Nonresidential equipment and intellectual property products increased at rates of 17.2% and 13.05%, respectively.  Government consumption and investment increased at an annual rate of 4.4%.  Imports grew at a faster rate of 21.4%, compared to exports, which increased at a rate of 12.9%.

The BEA breaks down how much each GDP component contributes to total GDP growth.  Personal consumption expenditures contributed 1.08% to the 2.0% increase in GDP for the quarter.  Gross private domestic investment contributed 1.48% to GDP.  Net imports had a negative impact of -1.30% on GDP growth.

Some economic analysts are concerned that most of the GDP growth was due to investment related to the artificial intelligence (AI) buildout and returns on investment for many of the AI initiatives remain uncertain.

Personal consumption is unlikely to be a major source of economic growth in the near future as it has grown at a faster rate than personal income during the past year.  The personal savings rate has declined to 3.6% as of March 2026, which is the lowest rate since November 2022.

Federal government spending may increase substantially for the next fiscal year beginning October 1.  The White House budget request includes $1.5 trillion for defense spending, a 42% increase from the current level of $1.05 trillion.  The Congressional Budget Office is projecting that the budget deficit for the current fiscal year ending September 30 will be $1.9 trillion with total expenditures of $7.4 trillion.  The budget request is currently under review by Congress and analysts expect an “uphill battle” for approval, even with the current Republican majorities in both chambers.

According to www.multpl.com, the S&P 500 index remains at a high valuation level with a P/E ratio of 31.0 based on reported earnings for the last twelve months.  The Shiller P/E ratio which is cyclically adjusted for the past ten years is higher at 40.9.

FINRA margin debt also reflects a high level of speculative interest, at $1.22 trillion as of March 31, more than double the $607 billion for December 2022.

Research Affiliates is currently showing a projected nominal annualized return for the next ten years of 3.5% for US large cap stocks.  Research Affiliates avoids prognostications on the US economy or geopolitics.  Their expected returns simply reflect a steady state economy and a return to more normal valuation levels.

While expectations are low for the S&P 500 index, there are some stocks that sell at reasonable valuations with good fundamentals.  Companies that we own include Verizon, SM Energy, Paypal, Allstate, Danaos, and Global Ship Lease – all of which continue to report revenue growth and sell at P/E ratios in the single digits.  The exchange-traded funds that we own also have a similar value orientation.

If you have any questions or comments, please contact me.

Robert G. Kahl
CFA, CPA, MBA

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The Inflation Inflection Point

There was a positive reaction by the financial markets to Federal Reserve Chairman Powell’s comments on Wednesday this week.  He said, “The time for moderating the pace of rate increases may come as soon as the December meeting.” The last four rate hikes to the fed funds rate have been 75 basis points (0.75%), so he is indicating a rate hike of 50 or 25 basis points at the conclusion of the Federal Open Market Committee meeting on December 14.  The current fed funds rate target is 3.75-4.0%.

The financial markets paid less attention to Chairman Powell’s other remarks, which reflect the Federal Reserve’s concern of reducing inflation.  After his comment about the December rate hike, he said, “History cautions strongly against prematurely loosening policy.  We will stay the course until the job is done.”

Goldman Sachs strategists are forecasting a peak federal funds rate of 5.25% in May following a 50 basis point hike on December 14 and three more 25 basis point hikes next year.  Most economists expect inflation to trend lower as interest rates peak and supply constraints ease.

Rob Arnott, Partner and Chair of Research Affiliates and his partner, Omid Shakernia, recently published an article, “History Lessons: How ‘Transitory’ Is Inflation?”  The full article is located here: https://www.researchaffiliates.com/publications/articles/965-history-lessons.  Their conclusion is contrary to the consensus.  They cite a meta-analysis of 67 published studies on global inflation and monetary policy by Havranek and Ruskan (2013) which found that across 198 instances of policy rate hikes of 1% or more in developed economies, the average lag until a 1% decrease in inflation was achieved was roughly 2 to 4 years.

Arnott and Shakernia conducted their own study and examined all cases where inflation surged above 4% in 14 OECD developed economy countries from January 1970 through September 2022.  Their study focused on the level and trend of inflation.  Their conclusion had the following key points:

  • The US Federal Reserve Bank’s expectations for the speed of reverting to 2% inflation levels remains dangerously optimistic.

  • An inflation jump to 4% is often temporary, but when inflation crosses 8%, it proceeds to higher levels over 70% of the time.

  • If inflation is cresting, inflation levels of 4 or 6% revert by half in about a year. If inflation is accelerating, 6% inflation reverts to 3% in a median of about seven years, threatening an extended period of high inflation.

  • Reverting to 3% inflation, which we view as the upper bound for benign sustained inflation, is easy from 4%, hard from 6%, and very hard from 8% or more. Above 8%, reverting to 3% usually takes 6 to 20 years, with a median of over 10 years.

Arnott and Shakernia believe that the consensus view that a short “transitory” period of high inflation will soon pass places too high a probability on the best case and ignores economic history.

If you have any questions or comments, please contact me.

Sincerely,
Robert G. Kahl
CFA, CPA, MBA