This business expansion has gone on for nine years and most investors think we have to be near the end. In baseball parlance you hear talk that we are in the seventh or eighth inning; nobody seems to believe we are in the second or third. Jamie Dimon of J.P. Morgan has said at a conference we’re in the sixth, which got a lot of attention. Those who are cautious on the outlook talk about how corporate cash flows will be inadequate to service long-term debt obligations. They also raise macro issues like the large U.S. budget deficit, declining American competitiveness, worsening relationships with our trading partners, Middle East instability, a slowdown in Europe, difficult 2019 earnings comparisons and displacement of white collar employees by artificial intelligence.

We believe that the current business cycle has at least several more years left to run. The major signs that would herald the beginning of the next recession are not yet in place. Unemployment is low and likely to decline further; wages are rising, but not sharply; the Federal Reserve is tightening, but real interest rates are zero; inflation is moving higher slowly; the yield curve is not inverted; profits are increasing; and the leading indicators are still rising. Until some of these indicators change, the expansion is likely to continue.

Policy makers will try to keep the expansion continuing as long as possible. I believe that they recognize that if we get into a recession, we do not have the traditional tools to get out of it. The usual pattern for the U.S. economy when it is in recession is either for the Federal Reserve to lower interest rates from a high level to stimulate business activity or the Keynesian method of providing fiscal stimulus. At this point, even though we are presumably late in the cycle, interest rates (Federal funds) are still low and a year from now, even with continued rate increases every quarter, they are still likely to be less than 3%. Lowering them from there would not likely bring on a surge in the economy because the real rate of interest would only be a still low 1%, not much different from zero, where we are now. The two-year / ten-year spread is, however, tighter. In terms of fiscal spending, the Trump Tax Cut and Job Creation legislation is likely to increase the U.S. budget deficit from $700 billion to $1 trillion, making it about 5% of gross domestic product. This is the highest we have experienced in peacetime. A Republican Congress is unlikely to want to increase the budget deficit from the current level even if real economic growth slows back below 2%.

Our bullish thesis will likely be tested this summer. Mid-term election year stock market performance is notoriously bad. Historically, the market has corrected an average of -18.9% from peak to trough leading up to the election, based on data going back to 1962. But July in particular is typically the most painful month, as history shows it is the month when the market loses its gains, turning negative in the year to date column. Over the years there have been many theories attempting to explain the weakness seen around mid-term election, none particularly good, but still the pattern seems to persist. The summer months may be rough but we are optimistic for year end, and stick with our S&P 500® target of 3,000.