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Despite rising global trade tensions and weakening manufacturing output, the U.S. economic expansion that began over ten years ago continues.

Oct 2019
Julianna Donovan

Second quarter Gross Domestic Product (GDP) grew 2.3% year-over-year compared to 3.2% a year earlier. Early estimates for the third quarter suggest 2.0% growth. Broadly speaking, the slowdown reflects decelerating business spending, inventory accumulation and declining exports. Looking ahead, we expect growth of about 2% for this year and the first half of next year, which is slower than the 2.9% rate for the full year in 2018 when tax reform accelerated both corporate and consumer spending. Despite all of the uncertainty surrounding global trade and tariffs, there are three components that we believe will continue to propel economic growth.

Labor Market

In September, the unemployment rate fell from 3.7% to 3.5%, the lowest level in over fifty years, as shown in the chart on the following page. It is good news that the job market is holding up despite headwinds to growth. While job creation has slowed, the latest estimates point to about 135,000 new jobs added in September. Most skilled workers who want a job can find one and many vacancies exist for less skilled positions, especially those paying close to minimum wage. In the past, economic peaks have been marked by hiring freezes as an early indicator of a stalling economy, with companies reluctant to add labor in the face of uncertain demand. So far we have not seen this, nor have we seen any contraction in the labor market. Even with a slowdown in job growth in 2019 the unemployment rate has still fallen.

U.S. Consumer

Consumer spending grew at 4.5% in the second quarter and is estimated to grow roughly 2.5% in the third quarter. Growth in wages (shown in the chart) helps to offset slowing job growth and supports total household income and spending. Household net worth has risen substantially as a result of the wealth effect from rising asset prices such as equities and real estate, but also underpinned by employment and wage growth, low borrowing costs and a lower debt burden relative to recent history. This effect is especially important as it feeds through to consumer confidence and demand. Ultimately, consumption accounts for nearly 70% of the country’s economic output.

Monetary Policy

After raising rates for three years, the Federal Reserve (Fed) reversed course by steadily lowering interest rates this year, and will likely cut rates once more before the end of the year. We view these actions as a type of pre-emptive “insurance” designed to keep borrowing costs low and encourage spending in order to sustain the expansion. Historically, the Fed has avoided large changes to the policy rate in the year of a general election, which could be another reason why they are choosing to act now.

While the slowdown in growth and increasing uncertainty of global trade put the economy at greater risk of a recession, our belief is that the chances of recession in the U.S. within the next twelve months are low.

With employment stable and consumer spending holding firm, a near-term contraction in growth for two consecutive quarters (characterizing a recession) is unlikey. Furthermore, the cyclical sectors of the economy such as autos, housing, business investment spending or inventories do not appear to us to be over-extended. Regulation and higher capital requirements have greatly reduced risk in the financial system. Without the irrational exerburance, speculative excess or bubbles that marked prior peaks, it is hard to envsion a bust that would lead to a shock to the economic system and a sharp decline in demand. With that said, we are increasingly aware of select imbalances whether in private equity or pockets of real estate, but we believe their potential un-doing would be far less harmful to the real economy than the bursting of a nationwide bubble in home prices, for example. We expect the U.S. economy to remain in a low growth, low inflation environment with modest job creation. While this outlook does not portend imminent recession, it is not a “gangbusters” forecast and will likely have implications for lower investment returns, as we describe below.

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