Notes on the Economy – 4Q 2019 Summary

TURNING THE CORNER

The advance estimate from the Bureau of Economic Analysis shows growth of third-quarter real GDP (total output of goods and services) for the United States was 1.9%. Second-quarter growth was 2.0%. Both represent a considerable slowdown from first-quarter’s growth of 3.1% and fall well short of consensus expectations held earlier in 2019.

The slowdown in the U.S. economy is not an isolated occurrence. Global data show widespread weakening in trade and production, particularly in manufacturing, in many countries. Growth expectations for global real GDP have been downgraded. The International Monetary Fund (IMF), projects global real GDP growth for 2019 will be 3.0%, versus 3.7% and 3.6% for 2017 and 2018, respectively.

Although there are some common elements that bear on slower global growth—e.g. increases in tariffs, high and lingering uncertainties around trade policies, and contraction in the auto industry—idiosyncratic elements play a contributory role in most economies to greater or lesser degrees. In the United States, reduced production of Boeing’s 737 MAX aircraft and of autos during the GM strike are examples. Still, as in the United States, service sectors are growing fast enough in most countries to allow total economic output to expand. Also, most central banks, the U.S. Federal Reserve Bank (Fed) included, have bought into a cycle of policy easing.

WHAT’S IMPORTANT

• Do Not Worry About Recession — Recession risks are elevated, roughly in the range of 20% to 35%, judging by the estimates of those that do such handicapping. Even at face value, that is far from 100% and the chance for a recession that repeats the severity of the 2008-2009 experience at this point is remote.
• Fed Interest Rate Cuts Are In The Past — The Fed’s “mid-cycle adjustment” is complete. The federal funds rate target will probably be unchanged over most, if not all, of the coming year, and the next Fed move will be an increase.
• Be Wary of High-Yield Bonds — In spite of apparent liquidity in the high-yield credit market, indicators of stress have emerged. Capital outflows from the market could amplify stress, warranting investor caution.
• Globally Diversify Equity Portfolios and Tilt Toward Value Stocks — Diversification helps mitigate risk in an environment of heightened uncertainty, and the valuation and expectations gap between value and growth stocks, globally, remains substantial.

LOOKING AHEAD

Fourth-quarter growth is on track to be the weakest of the year due to adjustments that overshoot (as, for example, when consumers normalize spending from a blowout second quarter) and due to temporary impediments such as the 737 MAX grounding and the GM strike. In passing, it is noteworthy that lagging growth at home and abroad raises the risk of recession. Still, that is not the most likely near-term path for the U.S. economy.

Rather, the odds favor turning the corner in late 2019, producing a rebound in growth during the first half of 2020. The Fed has already made its move, cut the target range for its policy interest rate three times in the third quarter. The real policy interest rate (i.e. interest net of inflation) is below zero and unquestionably expansionary. Fiscal policy will also provide support, first to private demand as a result of the 2017 tax cuts and second through government spending from the 2019 compromise federal budget legislation. By early 2020 consumer spending will rebound supported by a still-strong labor market and favorable household financial conditions; business fixed investment will soon follow.

Generally, foreign economies should also experience improvement in 2020. Conditions vary but major central banks have been implementing policies that support improved financial conditions and cut downside risks to growth. Global auto industry issues should prove temporary, and some lessening of trade tensions seems probable. A number of emerging and developing economies that experienced recessions or significant slowdowns in 2019 appear to be improving. The IMF forecasts global growth of 3.4% for 2020.

To receive a full copy of the Executive Summary or the entire 30+ page “Notes on the Economy” report, contact your AMG advisor or submit a request for more information.