Economic news releases in June showed the U.S. economy is still slowly recovering and expectations remain low for future growth. The threat of inflation appears to be subdued based on the Labor Department's June Consumer Price Index and Producer Price Index. Consumers changed their outlook on the economy in June based mainly on their expectations for the labor market and fiscal policy. Their sentiment appears to be on track with labor market growth in June which remained stagnant.
Consumer Price Index
The CPI was unchanged for the month of June. Decreasing energy prices offset increases in food prices. Gasoline prices have been steadily falling, keeping overall energy costs for consumers down. The energy portion of the index fell 1.4 percent for the month. The food index increased only slightly for the month, up 0.2 percent. On a year-over-year basis the CPI has increased 1.7 percent, which keeps it in check with the Federal Reserve's target rate of 2 percent.
Producer Price Index
The PPI, a second measure used to gauge U.S. inflation, increased 0.1 percent for the month of June. The PPI differs from the CPI in that it tracks the price producers are charging for finished goods. The PPI also increased on a year-over-year basis, adding 0.7 percent to the price of all finished goods.
The Thomson Reuters/University of Michigan Index of Consumer Sentiment fell 7.7 percent in June as consumers changed their outlook on the economy. June's decline was the first decrease in nine months, signaling a depressed outlook on the economy's growth prospects leading up to the November election.
Consumers appeared to continue benefiting from lower gas prices in June but that was overshadowed by their expectation for future increases in the unemployment rate. An unfavorable outlook on fiscal policy decisions also pushed the Index down in June.
Upper income families had the greatest influence on the Index's direction for the month. Their expectations for financial improvements in the next 12 months decreased to 24 percent from 37 percent in the previous month. Their buying plans for vehicles and durable goods also fell by 10 percent and 14 percent, respectively.
Growth in the labor market remained stagnant based on the Department of Labor's June Employment Situation report. The report showed an overall increase in nonfarm payroll jobs of 80,000 for the month of June. This kept the unemployment rate unchanged at 8.2 percent.
Consumers' negative labor market outlook appears to align with July unemployment data. Cumulative July unemployment claims reported by the Department of Labor have totaled an increase of 8,000 for the first two weeks of the month.
June housing data further supported the economy's depressed outlook. Existing-home sales fell 5.4 percent in June, according to the National Association of Realtors' monthly housing report. The decrease was attributed to tighter inventory supply. Housing inventory fell 3.2 percent in June, according to the report, which increased the month supply to 6.6 from 6.4 in May. The increased month supply further exemplifies the slower pace occurring in housing sales.
The U.S. housing market, however, still continues to see low mortgage borrowing rates that could help it to continue gaining momentum in the second half of the year despite the economy's weak outlook. Freddie Mac's July 19 weekly Primary Mortgage Market Survey reported new all-time lows for 30-year and 15-year average fixed-rate mortgages. The 30-year average FRM was 3.53 percent and the 15-year average FRM was 2.83 percent, based on the agency's weekly survey.
Overall, June's economic data seems to signal the beginning of a downward trend leading into November's election. It appears market sentiment is beginning to factor in the risks involved in solutions for tackling the federal deficit, creating a headwind for U.S. economic activity through the end of the year.
Although a number of proposals for reducing the federal deficit are up for debate, increased corporate and personal taxes and decreased spending are inevitable. These effects would add downward pressure on stock valuations and equity markets. Federal debt is also projected to reach its ceiling again near the same time as the November election which will add increased volatility for equity markets.
Federal Reserve Chairman Ben Bernanke reiterated the U.S. economy's fragile state in his semi-annual address to Congress on July 17 and 18. In comments following the address, many government officials expressed a desire for more monetary stimulus from the Federal Reserve which appears to be helping corporate profits through decreased capital borrowing rates. Additional interest rate easing, however, is not likely to generate the same results or outweigh the effects of higher taxes and decreased spending needed to reign in the federal deficit.
This bearish equity outlook for the second half of the year and the low returns on fixed-income securities leave few safe havens for investors. One asset class that does look attractive given the current investment environment is municipal bonds.
Municipal bonds are not taxed at the federal level and in many cases are exempt from state and local taxes as well. The SPDR Barclays Capital Municipal Bond Fund (TFI) is one passive ETF that can provide a tax shelter for investors. The fund tracks the Barclays Capital Municipal Managed Money Index and has a current SEC yield of 2.24 percent with a taxable equivalent yield of 3.45 percent. Consistent with passive ETF expenses, the fund also has a low net expense ratio of 0.23 percent.
For investors seeking to protect their equity allocations from tax reform mandates, tax-managed equity funds may be a good option. Dimensional Fund Advisors offers a number of tax-managed equity funds designed to avoid dividend and capital gains taxes. The fund manager's Tax-Managed U.S. Equity Portfolio (DTMEX) has a year-to-date total return of 8.97 percent and a net expense ratio of 0.22 percent.