How much longer can this last? After nearly a decade of economic growth, this is the primary question.

Oct 2018

Let’s address the question by taking stock of where we stand today.  As we have noted in the past, this has been an extraordinarily long expansion.  The average length of the 22 prior expansions since 1900 is 47 months.  At 111 months and counting, the duration of the current cycle is more than double the average.  While the rate of growth has been sub-par, we have recently seen a late-cycle acceleration to 4.2% GDP growth in the second quarter of this year.   That is an impressive pickup and is largely due to fiscal stimulus generated by last year’s corporate tax reform.   A 4% pace is not sustainable, in our view, as it likely includes some demand which was “pulled forward” from future periods due to the threat of trade tariffs.   We expect growth to slow to around 3% for the full year, and 2.5% for next year – respectable growth to be sure.   Barring some exogenous shock to the economy, we do not anticipate that a recession is imminent.  Here is why:

  1. The labor market is very strong.  The unemployment rate is 3.7%, the lowest rate since 1969.  An estimated 19.7 million jobs have been added since the expansion began, vastly exceeding the 8.8 million jobs lost during the 2008-2009 recession.   While pockets of “underemployment” remain across certain sectors and geographies, we are essentially at full employment.  Normally such job gains would be accompanied by upward pressure on wages.  Instead, growth in wages has only recently accelerated to 2.8%.  While not great news for workers, wage increases that are modest help to maintain peak corporate profit margins and likely sustains a robust employment environment.
  2. Consumer confidence and spending are high. Consumer confidence rose to an 18-year high in September (see the chart on the previous page), supported by the strong labor market, tax reform, and a decade of rising asset prices.  With about two thirds of the U.S. economy tied to consumer spending, this measure is also a positive indicator of future growth.
  3. Monetary policy is tightening gradually, but remains generally accommodative. Central banks have been gradually moving away from “zero percent” interest rates, with the U.S. Federal Reserve (Fed) leading the way.  But at 2.25%, the federal funds rate is still very low, and remains close to zero on a “real” basis (after adjusting for inflation).   We expect another hike by the Fed later this year, and several more next year.  We think the Fed will be cautious, not wanting to cause growth to falter.   The gradual unwind of the massive $4 trillion Fed Balance Sheet is also increasing in pace, putting upward pressure on long-term interest rates.  So far, this has been orchestrated without a shock to the economy or the financial markets, but it is something we are watching closely.
  4. Finally, we do not see signs of broad speculative excess, irrational exuberance, or large economic imbalances that have characterized prior economic peaks. The two prior expansions collapsed after the bursting of the technology bubble in 2000 and the credit crisis in 2008.   Financial conditions are much more stable currently.   While there is some risk of an escalating trade war with China, we see a reasonable probability of a negotiated agreement that limits the economic fallout, similar to recent agreements with Canada and Mexico.

So while we are certainly closer to the end than the beginning, we see further room to run.   We would also note that while the severity of the 2008 correction is still a painful memory, we expect the next correction to be much milder.    Many lessons have been learned from the Great Recession, and the excessive leverage in the consumer and financial sectors has largely been corrected.   So even when the next contraction does occur (which it will, inevitably), we believe it is likely to be more manageable.

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