What Investors Need To Know As We Head Into Summer (VOO)

From Invesco: Investors have no shortage of headlines to absorb as we approach the summer months. Below, I highlight five key takeaways from last week — featuring a new federal budget proposal — and preview two questions that will be answered this week concerning jobs and productivity.

Five key takeaways from last week

1. Federal budget proposal outlines the Trump administration’s priorities. The Trump administration released its first budget proposal for 2018, making a strong statement about several key agenda items or “pillars”: health reform, tax reform and simplification, immigration reform, reductions in federal spending, regulatory rollback, energy development, welfare reform and education reform.

The budget proposes deep cuts to domestic programs — a decline of 20% from the 2017 budget. Most federal agencies did not go unscathed, but those hit particularly hard include the Environmental Protection Agency, where proposed cuts for 2018 are more than 30%. Also seeing a big drop in funding would be the Department of State, the Department of Labor and the Department of Education. There are also significant cuts proposed to aid programs for those in poverty such as Medicaid, the Supplemental Nutrition Assistance Program (known as SNAP or food stamps), the Children’s Health Insurance Program (CHIP), Social Security Disability (also known as SSDI; it is not to be confused with Social Security Retirement), Supplemental Security Income and tax credits for the poor. It is important to note that the budget proposal does not touch Social Security and Medicare.

The budget proposes an increase for several different agencies. The Department of Defense would get a 10% increase in its budget for 2018, while the Department of Homeland Security and the Department of Veterans Affairs would see increases of more than 5%.

The budget is predicated on expectations of 3% economic growth by 2021 through stimulative tax reform. Some economists argue it will be difficult for the US to reach 3% growth despite tax reform, and their arguments have some merit given productivity has faced limitations, arguably from demographics and low capital investment. In addition, I believe this budget is flawed in that it anticipates this higher growth level as a result of tax reform, but does not calculate the lost revenue from the tax reform.

Think of this budget proposal as more of a statement about the administration’s values and priorities. Congress may take a similar approach to the one it took with the Obama administration’s proposed budget for 2017: largely ignore it and work on its own version of the budget. However, that doesn’t mean this process will go smoothly. There is the potential for some level of chaos given that so much is riding on this budget (the Republicans plan to pass tax reform as a reconciliation to the 2018 budget, which means it must sit in the queue behind the budget).

2. CBO assesses the AHCA while the Senate looks to rewrite it. The nonpartisan Congressional Budget Office (CBO) released its assessment of the American Health Care Act (AHCA), Congress’ replacement legislation for the Affordable Care Act. The CBO’s analysis shows relatively little difference in impact between this House-passed bill and its previous iteration, which had failed to receive the necessary votes. The key takeaways are that it will cost less and thereby lower the budget deficit by $119 billion in the first 10 years it is in place. However, the CBO estimates that it will result in 24 million Americans losing insurance, while most others will pay more for insurance premiums in the first few years. Given that the Senate has indicated its intention is to write its own replacement health care bill, this assessment is moot as this bill is essentially dead on arrival. All eyes are on the Senate, which is just beginning to work on its own version of the bill.

3. The Fed is committed to a gradual normalization process. The May Federal Open Market Committee (FOMC) meeting minutes were released. They indicate the FOMC is committed to a very gradual and thoughtful balance sheet normalization process — more gradual than some had expected. The Federal Reserve will slowly taper reinvestment rather than end it all at once — this is a far gentler approach than ceasing investment in one fell swoop, which is the approach the FOMC seemed to have been seriously considering at one point. And it seems the FOMC conceded to Minneapolis Fed President Neel Kashkari’s wish for transparency by agreeing to announce the caps it planned to set on Treasury securities and mortgage-backed securities that would be allowed to run off rather than be reinvested each month. The Fed tapered in the final stage of quantitative easing, and now it will taper in at least the first stage of quantitative de-easing. Some are arguing that because normalization will be so gradual, the Fed 1) can start balance sheet normalization sooner; and 2) won’t have to slow down the pace of its rate hikes. I would argue that this is not necessarily the case and, more importantly, it does not seem fully priced into markets. That doesn’t mean it won’t gradually become fully priced in, but we’ll need to follow the situation closely.

4. The strength of political alliances comes into question. I’ve talked a lot about the theme of political disruption, in particular about populism, de-globalization and the threat to long-standing institutions such as the European Union and North Atlantic Treaty Organization (NATO). That theme seems to have only become more prominent in the last few days with the president’s meetings in Europe. It marked the first time since 1949 that a US president did not explicitly endorse Article V, the collective defense clause of the NATO charter (informally known as “all for one, one for all”) and was a source of great concern — particularly since President Trump made some critical comments about NATO during his campaign. The key takeaway from the meeting came from German chancellor Angela Merkel, “The times in which we can fully count on others are somewhat over, as I have experienced in the past few days … we Europeans must really take our destiny into our own hands.” Germany’s foreign minister went even further by stating that President Trump had “weakened the West.” There is always the off chance that President Trump is taking an extreme position as part of negotiating tactics and fully expects to endorse NATO and maintain the US foreign policy status quo vis-a-vis NATO allies. However, at least for now, political alliances are clearly weakening among some countries and strengthening among other countries.

5. College savings takes the spotlight. Last Monday was May 29, also known as 529 Day. Named after the section in the legislative code that provides for a tax-advantaged savings vehicle for higher education, 529 plans are a powerful tool to help fund college, which is a critical goal given the very high — and rising — costs of college. According to studentloanhero.com, the average student graduated from college in 2016 with $37,172 in student loan debt. And, depending upon the kind of loan, interest rates can be as high as more than 7%. This is a very difficult burden to shoulder as young people begin their careers. But there is good news. Sallie Mae’s 2016 Survey on college saving shows that parents are saving more for college. The average amount parents had saved was $16,380, and the average amount they had saved in a 529 plan was $7,534. While that number has increased, there certainly is much room for improvement. The sooner parents begin to save, the better. And don’t forget — college savings isn’t just for parents but can be for grandparents, aunts, uncles, etc. If it takes a village to raise a child, it likely takes a village to pay for a college education.

Two answers to look for in the coming week

1. Will May’s jobs report echo April’s strength? The most anticipated economic event of the coming week is arguably Friday’s release of the May jobs report. Recall that April’s jobs report revealed that headline unemployment (called U3) declined to 4.4%, a level not seen in the last decade. A broader definition of unemployment (called U6), which includes people who are marginally attached to the workforce and those unable to find full-time employment for economic reasons, also experienced significant improvement. In my view, another strong jobs report will “seal the deal” for the data-dependent Fed at its June meeting, ensuring a rate hike, barring unforeseen circumstances.

2. What will revised productivity figures reveal? This coming Thursday we’ll get the revised report on nonfarm productivity and costs for the first quarter. The first estimate for productivity was -0.6%. Hopefully the revised estimate will be higher; weak productivity elevates labor costs as it takes more hours to produce the same item — so companies need to add additional labor to produce the same item at the same rate. Productivity is a topic certainly worthy of more discussion, particular given the Trump administration’s focus on it.

One final note: My commentary comes on Tuesday this week, as we at Invesco commemorated Memorial Day on Monday. I would like to remember the many brave US service members who sacrificed their lives for our country, and also thank their Gold Star families.

Subscribe to Invesco US Blog and get Kristina Hooper’s Weekly Market Reviews in your inbox. Simply choose “Market & Economic” when you sign up.

The Vanguard 500 Index Fund (NYSE:VOO) rose $0.16 (+0.07%) in premarket trading Wednesday. Year-to-date, VOO has gained 7.99%, versus a 8.04% rise in the benchmark S&P 500 index during the same period.

VOO currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #4 of 109 ETFs in the Large Cap Blend ETFs category.

Important information

The opinions referenced above are those of Kristina Hooper as of May 30, 2017. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.

This article is brought to you courtesy of Invesco.