A soft patch in the economy is dampening expectations for a stimulus-driven, postelection boom, prompting many investors to retreat from bets on growth.
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The first quarter marked the weakest U.S. growth in three years, according to the initial Commerce Department reading on Friday. The Federal Reserve's preferred measure of inflation, the personal-consumption expenditures price index, dropped 0.2% in March from a month earlier, pushing annual increases back below the central bank's 2% target, data showed Monday. Even longtime economic bright spots such as consumer spending and car sales have recently begun to fade, with sales at General Motors Co. (GM) and Ford Motor Co. (F) declining sharply in April.
Economists say these signs run counter to the bets on faster growth under President Donald Trump that fueled a postelection stock rally, reflecting early excitement about the likely impact of potential tax cuts, deregulation and infrastructure spending.
Investment managers are tempering their optimism, with 44% saying in a Northern Trust survey taken in late March that they expect the economy to accelerate over the next six months, down from 55% in the previous quarter.
"Moderate is going to be as good as it gets for the near-term, with a longer-term outlook suggesting even weaker growth," said Lindsey Piegza, chief economist at Stifel Financial Corp. Ms. Piegza believes the economy will grow at about 1.5% annually for the next one-to-two years before a recession takes hold.
That has implications for the Fed, which is set to keep rates unchanged when it concludes its May policy meeting on Wednesday. Investors have penciled in two more rate increases before the end of the year, with fed funds futures showing 70% odds of a June increase.
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Some see the slowdown as a passing phase. For years, the first quarter has been weak for GDP growth, raising questions about the Commerce Department's seasonal adjustment methodology and fueling expectations for a rebound in the April-to-June period. The economy could well get a boost if the White House and Congress pass a tax-reform bill or other measures that encourage spending, some investors say.
Others expect the Fed to continue raising rates, noting that a falling U.S. dollar, near-record stock prices and narrow junk-bond spreads all point to loose financial conditions.
But the souring in the current outlook reflects the evolution of a broader postcrisis trend, in which the economy has expanded steadily while struggling to grow at an annual pace above 3%. The U.S. is in one of its longest periods of expansion since the Second World War, but many fear that the economy will struggle to maintain even its modest pace of growth, much less accelerate rapidly.
Lacy Hunt, executive vice president at Hoisington Investment Management Co. in Austin, Texas, noted that the supply of highly liquid money, called M2, an indicator of overall demand, has grown at a below-average annual rate of 5.5% over the three months that ended in mid-April, down from 6.8% in 2016. M2's pace tends to rise and fall with demand for goods and services.
Another measure of the relationship between money and GDP, known as velocity, hit a fresh record low in the first three months of the year after more than a decade of decline. That in effect means for each dollar's increase in the money supply, the associated increase in output is falling.
Together with decelerating credit growth, tightening lending standards and a rising fed funds rate, slowing money growth and velocity suggest softer economic growth ahead, Mr. Hunt said.
"We're headed for a severe slowdown and the risk of an accident is high, " he said.
Citigroup Inc.'s (C) U.S. economic surprise index, which turns positive when data in aggregate are beating economists' forecasts and negative when they are missing expectations, turned negative on Friday for the first time since the week after the election. In mid-March the index was at its highest since early 2014.
Tom Forester, chief investment officer at Forester Capital Management, is largely shunning stocks that are trading at high prices relative to their earnings, since economic growth doesn't show signs of accelerating. Recently, he has also stayed away from retail stocks, which are sensitive to a weakening economy and suffering from a deeper shift away from brick-and-mortar shopping. He suspects these declines could point to broader slowing.
"We've peaked and started rolling over on a lot of these things like auto sales, factory usage and homes," said Mr. Forester.