Despite the Grumbling, Economy Looking Great

Economy

2019 has been a year where both the stock and bond market have performed extremely well, but also one that worries about the economy have also gone on and on.

Just looking at all the noise on the street, you would think that we were facing some difficult times with the economy which are set to only worsen over the next couple of years.

It’s not even the fact that the media needs to report on something and, given their preference for bad news, they are combing the bushes and coming up with all sorts of worries and fears from the man on the street. This racket mostly comes from people in the industry, in the investment industry at least, but a lot of people who we think are in the know don’t really know that much about economics it seems.

It’s not always enough to be a professional economist though, as it’s not hard to round up a few to sound off with the crowd, although most of this noise does come from the investment world. These are people who may have titles and companies paying them quite a bit of money but whatever they tell us must still pass scrutiny. With a little understanding, we can put ourselves in a position to evaluate the merits of these worries and even decide for ourselves whether the horizon is as overcast as they may think or whether things are actually looking pretty good.

It is well worth looking at these particular concerns and put them together with what we do know and what the actual numbers look like if we’re going to decide how likely hard times coming soon are and especially if we’re afraid of a recession coming soon.

To do this properly, we’re going to have to have some understanding of what causes recessions to know whether one is coming or not. Just polling company executives won’t do it, as we’re not looking for just someone’s opinion on this, we need to be provided evidence of some sort, and people worrying just doesn’t count.

It therefore doesn’t really matter what percentage of company executives think a recession is coming this year, next year, or the year after, because that in itself does not tell us anything useful. We need to be given reasons, although there’s no shortage of those either from the street, but the reasons need to be valid to be believable.

We can start with the worry over declining GDP growth. 2018 yielded a growth rate of 2.9%, and is currently projected to drop to 2.1% in 2019, 2.0% in 2020, and 1.8% in 2021. This sure looks like a decline, but that doesn’t mean much as we need to decide whether this decline is worth being concerned about or perhaps is even desirable.

Trump and the Stock Market Want to Stuff Themselves, But This is Not Healthy

President Trump thinks 2.9% is too small and would like to see 4% GDP growth, but thankfully for us, he doesn’t get to decide these things, even if he thinks that he does have a say in this. That would be a terrible idea economically actually, and this is why when GDP started out 2018 year in the 3’s, the Fed used both barrels on this to bring this down, in addition to the quantitative tightening they were doing, selling treasuries to look to slow down growth.

2.1%, 2.0%, and even 1.8% are much more like it, as the real threat right now isn’t more modest growth like this, it is growth picking up much more than this. We can’t just look at this number in isolation though if we’re looking to do a health check on the economy, as inflation and employment numbers matter a lot as well.

In terms of the growth numbers though, the economy gets a clean bill of health right now and actually looks pretty fabulous. If we can keep inflation in check and unemployment low with this, we’re actually in a pretty ideal situation.

Worrying about GDP growth hanging around 2% for the next 3 years therefore isn’t a concern, it should rather put a smile on our faces.

Although the worries about low yields or yield inversions has died down somewhat, there are still people concerned about this. This is just a sign of a very strong bond market though, and while the bond market will strengthen when a recession is approaching, it strengthening does not in itself portend a recession or anything else. This just means that a lot of people are buying bonds, and in the presence of a strong economy, this is not a negative at all.

The trade war with China has definitely cooled down growth to some degree, but we can’t just think of this in the abstract and say that the trade war will make a recession more likely. The actual effect of this on GDP growth has been negligible, even with all the extra guns that are going off lately.

Inflation is projected to be 1.5% this year, and with inflation, you want it nice and modest like this. If we are afraid of a recession, it’s higher inflation that we need to be worried about, and inflation too high is what causes recessions by itself a lot of the time. Prices rise faster than income, people spend less, productivity goes down, people start losing their jobs, and the whole thing cascades.

Inflation is set to rise to 1.9% in 2020 and 2% in 2021, both nice and modest numbers, the kind of numbers that both the Fed and the economy loves. These numbers, together with our projected growth rates, paints a beautiful picture of things to come and one we should be very happy about as long as we understand why this is beautiful.

Employment Numbers Tell the Real Story

If we are worried about recessions, employment rates are central to this, as what happens when we do get one is that the unemployment rate rises a lot and this really sends the economy into a tailspin. The Great Depression may come to mind here as an extreme version of this, with unemployment rates as high as 24.9%, but we only have to think back to 2008-09 to be reminded of this.

Unemployment climbed from 5% to 7.3% in 2008, and GDP growth dropped to –0.1%. The next year unemployment peaked at 9.9%, and growth dipped to –2.5%. While the two do influence each other, they also go together as well and we can’t have low unemployment and a recession.

If we’re wondering which is more important to economic health, in the years between 1934-1940, unemployment averaged 17.7% while GDP growth averaged 7.3%. That’s some terrible employment stats together with some very impressively large GDP growth numbers. This was a time where whether we were in a depression or not was not anything anyone questioned as these were very dark times indeed, but it certainly wasn’t the 7.3% positive growth that defined it.

Unemployment is projected to come in at 3.7% in 2019, 3.8% in 2020, and 3.9% in 2021. These are all very low numbers and way under the 6.7% we have averaged during the bull market of the last 10 years. The Fed’s target is right at 6.7% as well and we’re way below either of these, and this part of the report card is simply fabulous. This is also the most important element of the report card.

It’s actually pretty hard to imagine things being better, and even the tariffs might be helping all this out by keeping inflation more in check. The first order of business as well as the most important one right now is to keep this going, which means to not err too much on the side of stimulating the economy too much.

While the economy looks simply terrific, the stock market doesn’t always act as rationally as economists like to assume. In the end though, a strong and healthy economy will have its say once whatever fears people have play out, so this therefore bodes well for stocks for the next 2 or 3 years barring a big change to the negative.

It’s hard to even imagine what could bring on such a thing, short of an all-out trade war. That’s not likely though as both countries have too much on the line for such a thing and shutting out Chinese goods in the U.S. would be beyond political suicide.

This is truly a time for feasting otherwise, and stocks have well feasted on all this in 2019, especially given all the stock buybacks that this has brought on. With quantitative tightening over and a quarter point rate cut, this brings even more food to the feast, although we do need to make sure we don’t gorge ourselves too much and start going the way of higher inflation.

This means that the Fed will continue to need to show good judgement, but this is not an economy that needs much more than a little tweak like it just got, if anything.