U.S. Economic Outlook: A case for Slow Growth but No Recession
The length of the current economic growth since the Great Recession reached 113 months in December 2018, making it a second longest of the 11 expansion periods since the end of World War II. By July 2019, the current growth cycle will match the longest expansionary period in the U.S. history, which occurred from March 1991 to March 2001. But, as the economic growth continues, many economists are starting to wonder when the next recession will begin and how that will affect their business. We forecast economic growth to moderate in 2019 and continue with slow economic growth during 2020 through 2023 – but the economy will avoid recession.
KC CRE Advisor’s base-case scenario shows annual average GDP growth to simmer down from its 2.9% in 2018 to 2.2% in 2019. We expect GDP growth to decelerate further to 1.6% in 2020 and average 0.8% in 2021 and 2022. Magnitude of growth is once again expected to pick up starting in 2023. Negative territory is nowhere in sight. Slow to flat growth in 2021 and 2022 may feel like a recession, but it will not meet the textbook definition of recession, which is a “period of economic decline (GDP contraction) lasting for two consecutive quarters or longer.” But keep in mind, we are not applying outside shock or recession scenarios to the GDP forecast.
The corporate cash hoarding that started during Obama administration is somewhat continuing. We also saw about 60% of $1.5 trillion tax cuts passed in December 2017 go to corporations and its shareholders. Some cash came back to the U.S. from overseas during 2018, helping boost wage growth and investment. So, U.S. businesses are in a healthy place and may have more cash in hand than you might think. Corporate profits have remained well above the trend line since the Great Recession ended. Though corporate profits are expected to decelerate during the forecast period, years of elevated profits and current money in hand could be used to invest, since business and consumer confidence will remain elevated during 2019 and 2020, keeping GDP growth in a positive territory.
With household net worth increasing, mainly due to home equity, consumer confidence and spending alone can help avoid the short-term-recession scenario through 2020. Don’t under-estimate the power of the U.S. consumers, who hold about 70% weight in the GDP calculation. Consumer spending pulled through during the recent holiday season, providing good momentum heading into 2019. With wage growth expected to increase at an above-average rate during 2019 and 2020, consumers are expected to do their part to keep the economy moving in the right direction. But proper economic policy is a must, as business and consumer confidence by itself is not enough to sustain economic growth for a long period of time.
Whether our base-case scenario is realistic depends much on economic policy set by Congress, the Trump administration and the Federal Reserve. The Fed is expected to manage the base interest rate more carefully, as it is getting some pressure from the administration to tone down the increases. Our view is that the Fed is trying to raise the federal funds rate to the point where it can play an active role in any potential downturn. But does it make sense to add to the jitters in the market now when inflation is already tamed? Also, interest rates remain low compared to historical standards, but business and consumer sensitivity to rate hikes has increased. Even if the Fed increases the rate gradually, it will be 2021 before it can reach a point where it can significantly help during a downturn.
And if President Donald Trump can deliver a good trade deal with China and other trading partners, pass an infrastructure spending bill with Congress’ help and continue on the path of business deregulation – which would give business and industry more freedom to operate and add jobs – the economy may well keep humming along in a slow-growth environment. But it will be growth, nonetheless. A more impactful policy option to avoid a short-term dip through 2020 would be to give consumers tax cuts. Any meaningful fiscal policy to help the economy needs to come within mid-2019. Once the Democratic House of Representative gets deeper into subpoenas and investigations, all bets are off.
Cooperation between the President and Congress needs a middle ground, since the politics of Classical vs. Keynesian economics usually is not a clean fight. Both the President and the House Democrats have something to gain and lose if deadlock occurs, leaving the U.S. economy vulnerable to a downturn during the outlook.
Recession Indicators: A Case Against Recession
One of economists’ hardest jobs is to predict when a recession would begin and how deep it would be, since its potential start and depth depend on several unknowns that could happen any time. That’s why oligopolies that provide economic forecasts generate over 20 different scenarios with no clear base case. Having said that, there are recession indicators that somewhat give warning signs, but do not identify the exact recession dates or depth. We analyze three main recession indicators that tend to catch the most attention of the masses: Recession Probability Model, Yield Curve and Unemployment Rate.
The unemployment rate is lesser-known of the three recession indicators, but it has been a fairly good one. When unemployment falls below 5%, as it has in all but two months since January 2016, a recession usually follows within the next two to three years. During the most recent two recessions, it took about three and four years, respectively, for a recession to start after the unemployment rate went under 5%. By this account, we have already reached three years with unemployment below 5%, but most headline economic indicators don’t point to a recession in 2019. In our view, the deeper correction seen during the Great Recession and the slow recovery afterward extend GDP growth beyond 2020.
First, the average GDP has been 2.2% during the current recovery, significantly lower than the 2.7% average during the 2001-2007 expansion and the 3.8% in the 1991-2001 recovery. The slower growth means there is more room left for the economy to keep expanding. If you take job loss from the Great Recession into account, the U.S. economy has produced only about 11.5 million jobs in the last 11 years. Historically speaking, this is well below the capacity of the U.S. economy.
Most economists argue that the lack of labor-force participation and the shortage of labor will constrain job growth during the coming years. Almost 95 million Americans are out of labor force. If we take away 95% of those people out of labor force permanently for variety of reasons -- demographic shift, in school, retirement and taking care of family members, among others -- we are still left with over 5 million people. Wage-growth increases and the settling of over-ambitious millennials to stable work will lure this crowd back to labor force during the forecast period. Add to this number new immigrants, though in lesser number than historical standards.
Piger, Jeremy Max and Chauvet and Marcelle’s smooth U.S. recession probabilities remain low as of October 2018. The model combines non-farm payroll employment, the industrial production index, real personal income and real manufacturing and trade sales. The recession probability, now 0.8%, would need to reach at least about 40% to somewhat guarantee a recession in the near future. Obviously, we are nowhere near that number.
The yield curve, which is the difference between the long- and short-term interest rates (10-year and three-month T-bills) can indicate an upcoming recession. Last year and in other years in history, the yield curve has somewhat flattened, but the GDP growth continued. Using the yield-curve data, GDP growth in 2019 is expected to be similar to that of 2018. Extending the forecast beyond this year shows gradual deceleration in growth. But again, interest rate forecasts have a higher error rate, since it is one of the harder series to forecast. Before using yield spread to predict economic growth, understand that the determinants of yield spread now vs. history are different. Having said that, using it to carefully analyze the business cycle is OK, but exact rate forecasts are not recommended.
A Case for Upside of the Base-Case Forecast
Last year, the stock market corrected from years of a bull run, as some prices moving in a bubble territory fell substantially. A lot of “bad news” started to make the headlines toward the end of 2018: the stalled trade deal with China, Apple scare, government shutdown and an increase in fed rate hike (though expected), among others. We believe the stock market is just looking for any kind of “good news” to shoot back up and recover lost growth. For example, when the December 2018 retail sales numbers came out, the Dow Jones Industrial Average increased by almost 1, 100 points. If and when a meaningful trade deal with China is signed, expect stock prices to move up, increasing consumer and business confidence this year and beyond.
The past two recessions were driven by the bursting of a bubble in some sectors of the economy: technology in 2001 and housing in 2008, both of which were inflating well before the bust. No such bubble is occurring today. If you believed stock prices were in a bubble territory, it is over. Without a provoking bubble, the five-year outlook would be driven simply by the economic cycle. Industries will have ample time during 2021-2022 to evaluate their positions and can react starting in 2022 to increase the magnitude of GDP growth.
Most oligopoly economic data and forecast providers show 2020 as a recession year. Since 2020 is a Presidential election year, would President Trump let a recession occur? Will the President have enough economic stimulus left to inject to the economy? American voters tend to blame the President for any recession, since “the buck stops here.” We expect some bipartisan “economic” bill signed by the mid-2019, which will help carry the economy through at least 2020. If House Democrats don’t go all out on investigations, expect further cooperation and continued growth during our five-year outlook, assuming President Trump wins re-election. By then, expect more cooperation as the administration will look toward bringing the country together and strive for positive outcomes for historians to look back on. But if he doesn’t win, the change to an administration with a new economic plan is expected to boost the economy, avoiding recession at least through 2023.
Finally, only a very few large economic forecast providers dominate the private-industry market, and the government to provide economic forecast data. So, they tend to drive almost every industry’s outlook with very little input from industry practitioners. This is very similar to the “bubble” concept, in which the “noise” keeps building the hype. Because recessions are hard to predict, a clearly articulated house view is a must for a short- as well as long-term economic outlook for your industry.