Is Our Economy Slowing Down?
Should we be prepared for the worst, a recession a stock market free-fall? Well, if you search the web using the title phrase, the search yields 169 million results in 0.64 seconds. Where was this library card when I was going to school?
Lots of predictions are out there calling for global slowdowns and a U.S. recession in 2020. So let’s go through the puts and takes:
Unemployment – the canoe is nearly full, that’s for sure. As unemployment drops below 4% (we stand now at 3.8%) on an absolute basis, job expansion slows and so do wages, attenuating consumer spending which remains the biggest contributor to GDP. Wages continue to increase; year over year wages have increased by 2.2% since last February. Participation rates have also begun to increase, meaning folks who had given up looking for employment, are now joining the labor force. In the short-term, this indicator is still suggesting we are in a growth mode although as the boat gets full, it may be indicating employment may continue to increase but at a slower pace.
Leading Economic Indicators as published by the Conference Board’s LEI® suggests we are in expansion mode still. The indicator increased 0.2% in February although at a slowing pace. A recession usually develops when this indicator is off by more than 1.0% when compared to the previous year.
Corporate Profits – we are coming off the highs. According to S & P Dow Jones Indices, the highest operating margin was achieved in the third quarter of 2018 posting a margin of 12.13%. The last calculation for the fourth quarter of 2018 resulted in a margin of 10.10%, double what was recorded in the first quarter of 2009, but approximately 17% of the high-water mark. Earnings are expected to rise in 2019 by about 9% over 2018 and increase yet again in 2020 by around 12% over 2019 according to estimates by Dow Jones Indices. In my opinion, the 2020 estimate is a little rich.
Interest rates have risen significantly bringing short-term rates closer to long-term rates. The increase in rates is a function of The Federal Reserve Bank’s policy in trying to keep inflation in check. So far we have not exceeded the 2.0% inflation target, and so it does not appear we will have to contend with an inverted yield curve shortly. An inverted yield curve, when the long term rates are lower that short-term rates, is a harbinger of recessions.
Housing starts continue to increase reaching 1,345,000 new permits in January of 2019 compared to 1,366,000 starts in January of 2018, down 1.5%. This indicator would have to decline by more than 10% year over year to point towards a recession.
Recessions usually start when severe imbalances are evident. Today there is no evidence of excesses.
We’ve had slowing economies before without heading into recessions. We are probably on the downhill side of the slope as our economy may be beginning to touch the ceiling. A neutral period may be more likely as inflation is tame and more folks join the workforce.
No recession is imminent at this point in our opinion, the data from the St. Louis Federal Reserve and the New York Federal Reserve Bank show negligible probabilities of recession. A slow down is probably taking place. I’ll take it; it’s a nice manner in which to avoid severe drawdowns. Having said that, as margins decrease and costs increase for companies we would expect earnings misses to increase and this, we believe, will increase the swings in equity prices.
Slow Down yes, recession no….
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Carlos Dominguez – Portfolio Manager, RJFS
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