Happy Holidays or Bah Humbug?
Recently we reported on the headwinds facing the economy. We discussed uncertainty and that it would have an impact on the markets – it definitely has. Since then a lot has happened and we thought you may appreciate an update on what’s happened and what we see in the economy and markets moving forward.
We’ve heard and seen a lot of dichotomies: a strong economy and falling markets. Rising corporate profits, but rising farm bankruptcies and corporate debt. So what’s really going on out there and why? I wanted to share our view of the current economy and what we expect in the year ahead.
General Economic Outlook
Looking in the rearview mirror we’ve seen strong growth of GDP this year. Fueled by tax cut legislation, high consumer confidence, and a strong job market, Q2 GDP reached 4.2% – well above trend. So where are we headed and what are the worries? Markets and business owners have been struggling with 3 major concerns.
First, the political environment – who will lead and will pro-growth policies remain? Mid-term elections have answered that for now and we view the outcomes as generally positive – no change in policy and still hope for infrastructure spending.
The second concern has been Federal Reserve policy on interest rates. Prior to this week Chairman Powell had suggested the 4th rate hike this year was certain and that 3 more may be expected for next year. He said rates were still below neutral and worse that the Fed may want to get ahead of growth and expected inflation even though current inflation remains around the 2% Fed target. It spooked a lot of investors and business owners. Fortunately, this week Chairman Powell announced that rates were just below normal and that they had to weigh the risk of raising too fast as well as too slow. A big sigh of relief was seen as markets rallied, interest rates eased and dollar strength waned.
However, the third concern – tariffs and a US-China trade war – is still unresolved and this issue presents the real wildcard. It is probably the greatest dichotomy we are facing. Why? Because the amount, type, persistence, and acceleration of tariffs creates uncertainty in prices, inflation, costs and locations of manufacturing, and their overall impact on global growth. After all, the #1 and #2 economies of the world are squaring off. With the G20 meeting scheduled for this week there’s hope that at least a truce and/or a suspension of planned tariffs may emerge. We’re skeptical. Neither the President or Chinese leadership want to appear to give in – although both would probably welcome a face saving compromise.
So what does that mean for the year ahead? Wells Fargo recently forecast US GDP growth of 2.5% for Q4 and about 2.3-2.6% for 2019. We agree with their forecast unless we get a more positive outcome on tariffs. The slowdown in business spending and GDP could easily be reversed. US Corporate profits are up 28% year over year and recent tax legislation stimulus will still be positive in 2019. The global economy? Goldman Sachs estimates China slowing to about 6% GDP growth, but overall World GDP should be about 3.8% for next year. Hardly recessionary.
Implications for Specific Sectors
Oil prices have slipped nearly 30% since September. They’ve been driven by global over supply and concerns about slowing growth. However, Saudi Arabia and Russia are likely to cut production to support prices near the current range. Lower prices are a net benefit to global growth but could be problematic if they cause a contraction in the industry. We agree with the Deere & Co. CEO – he expects prices to remain profitable for fracking and is forecasting an increase in sales of heavy equipment for next year.
The recent reported increase in farm bankruptcies is real. The number in the last 12 months is more than double the 2013-2014 period and banks are seeing more borrowers fall behind on payments. A Minneapolis Fed analyst recently wrote “current price levels and the trajectory of current trends suggest that the trend has not seen a peak.” The culprit: lower prices for corn, soybeans, milk and even beef. It appears that overproduction is the underlying problem. Of course, the situation has worsened because of retaliatory tariffs from China. It seems dairy farmers are struggling most. Grain farmers have offset lower prices with higher yields, but generally farm income has been lower. Will this persist or worsen? Probably not if tariffs are removed in foreign markets and global growth supports higher commodity prices. We are cautiously optimistic.
We’re experiencing a building slowdown – units are down about 5% from last year. It is mostly a function of interest rate increases and concerns about growth slowing. But, we believe the Fed has noticed and therefore predict real estate building and sales will be steady in 2019.
Not as robust as 2017, but the projected increase of 4.8% for 2018 is still above trend. As long as the job market remains strong, so will spending.
Equity markets are generally over sold. As usual, prediction of worst outcomes and disaster are common for equity investors. It’s still about fear and greed. The bond market is a more reliable forecaster of future economic conditions and although 10 Year Treasury rates have fallen slightly they still remain north of 3%. We project interest rates and inflation to increase modestly in 2019 and the economic expansion to continue – probably at least into 2020. Remember, this economy didn’t really start to recover until 2013.
Fear of the unknown has produced a lot of volatility and concern. And while elections and interest rate fears are subsiding, worries over tariffs and a US-China trade war persist for good reason. We believe there is a path for better outcomes – ones that will support free trade and global growth, but we realize the pain inflicted on the Chinese economy will not be without collateral damage here. We hope things don’t get worse before they get better, but they might. In the end, we expect this too shall pass, moderate growth will continue and the markets will climb the wall of worry.
Please call with any questions or concerns. Happy holidays to you and your family. As always, thank you for your continued trust and confidence.
Donald J. Phillips, CFP®
Greater Midwest Financial Group, LLC.
3222 Rice Street
St. Paul, MN 55126-3047
Phone: (651) 490-9790 Fax: (651) 490-9788
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