Thanks Washington, But the Recovery Remains Soft

Last week, Washington actually helped Wall Street. Investors cheeredthe extension of the debt ceilingandmarket friendly comments from new Fed Chair Janet Yellenindicating that the central bank would continue its current policies.

But it’s not time yet to pop open the champagne and celebrate a full U.S. recovery. As I write inmy new weekly commentary, whilethe improving tone in Washingtonsupported stocks and other risky assets last week, it overshadowed the release of some relatively disappointing economic numbers.

In general, economic numbers have been soft year-to-date, and reports surrounding consumption and retail spending have been particularly weak. Last week’s economic numbers, which markets largely ignored, provided more evidence that the U.S. economy remains in an environment eerily similar to the last few years – one characterized by easy money, low inflation, but still only modest economic growth. In other words, even with benign monetary policy and less accident-prone fiscal policy, the U.S. recovery remains somewhat soft.

The latest disappointing economic news came once again from the consumer in the form ofJanuary’s retail sales figures, which showed a weaker-than-expected 0.4% monthly drop, and to make matters worse, December’s reading was revised down. On a year-over-year basis, adjusted retail sales are now up 2.6%, the slowest pace since late 2009.

At first glance, the deceleration in spending looks strange given the strong housing market and record level of household wealth. Whilesome of the weakness in 2014 economic data is clearly weather related, the main culprit behind recent disappointing sales data isthe utter lack of real-income growth. Disposable income is rising at just above a 2% annual rate, a three-year low and a pace that is barely keeping up with inflation.

Part of the weakness can be attributed to the slow pace of the labor market recovery, but longer-term secular factors are also at work. These include technological innovation, global wage competition, and a mismatch between workforce skills and available work. In the absence of some acceleration in wage growth, retail sales and household consumption will remain constrained, and since consumer spending accounts for close to 70% of U.S. economic growth, constrained consumption will continue to act as a drag on the overall economy.

So what does this mean for investors? There are a few implications.

  • Be less afraid of long-term bonds. Soft economic growth means that while rates are likely to rise as the Fed continues to taper, the rise will be modest. Under this scenario,long-term bondsare unlikely to be as vulnerable as they were back in 2013.
  • Remain cautious on segments ofthe market geared to consumption. So far this year, both consumer staples and discretionary stocks have trailed the broader market.

Sources: Bloomberg, BlackRock research

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