Most investors are ready to leave 2018 behind and focus on the New Year. But hopes for a smoother ride ahead are likely to be tested as familiar old risks and new uncertainties emerge upon an economy that is well along in its statistical life expectancy. No alarm bells, but a healthy assessment of the environment and an awareness of clouds on the horizon may help steady the ship if squalls do appear.
Americans are currently enjoying the second-longest period of economic growth in our history, and no immediate signs of retreat are in evidence. Unemployment hovers near 50-year lows at just 3.7 percent. New job creation has been a consistent bright spot, running consistently at around 150,000 new jobs per month. And at last, average hourly wages have begun to inch higher (3.1 percent over last year).
The Federal Reserve in its most recent Beige Book survey notes that all 12 of its districts report continuing growth, and further signaled that industrial output has increased modestly throughout the year on balance. And significantly, holiday retail sales surged at the fastest pace in six years, consistent with robust consumer confidence readings.
Yet despite the optimism, there are signs that the economic expansion is getting long in the tooth. Certain cyclical sectors like auto sales and homebuilding are often the first to show weakness. The recent announcement by General Motors of its intention to furlough workers and retool the product lineup was an acknowledgement that for car makers at least, the times they are a-changin’. Meanwhile the steady upward drift in mortgage rates has dampened housing affordability, especially for first-time buyers. Watch for signs of further slowing in other consumer discretionary sectors, especially big ticket items.
More fundamentally, the U.S. economy was the beneficiary of a massive stimulus in 2018 that has now largely left the bloodstream, namely the $1.5 trillion tax cut that took effect at the end of last year. Contrary to promises of the bill’s proponents (and entirely consistent with economists’ predictions), the measure failed to unleash a massive expansion in capital investment or be passed along to workers as big gains in wages. Instead, most of the tax savings to corporations were doled out to shareholders in the form of stock buybacks and dividends. The result was a brief boost of GDP growth from its 2.5 percent trend to around 3 percent for 2018, to be followed by a return to the previous trend level of growth in 2019 and beyond. The best recent analogy is the much-maligned “cars for clunkers” gambit of 2009 that briefly spiked car sales before they plunged back to their original pace.
One of the most reliable harbingers of an economic slowdown has been the interaction of interest rates; particularly, the difference or “spread” between 10-year Treasury bond yields and 2-year yields. When the yield on the longer bond slips below the short end, yields are said to be “inverted.” We are not there, but we have gotten close a couple of times this year. No signal is infallible, but the yield curve has historically been quite prescient. If yields do invert, expect a reaction from the markets.
Most economists expect the status quo to prevail for at least the next year, with low unemployment and GDP growth around 2.5 percent, all else equal. The biggest visible risk is a continuation of the restrictive trade policies or in the extreme a full-on trade war that sinks the global economy. Absent a trade error, the current expansion could continue throughout the New Year. Still, it is prudent to remain on watch for the shoals.
Christopher A. Hopkins, CFA
Vice President and portfolio manager
Barnett & Company