Fundamentals Matter: 2019 Economic Outlook

Jan 22, 2019

By: Keith Prather, Armada Corporate Intelligence

Many of us have heard of the famed “Wall of Worry” that purveys through the financial media today. It is the cumulative fear of events from Brexit to a China trade war, the inverted yield curve to an overzealous Federal Reserve and everything in-between that affects executive behavior. Sometimes we need to step back and ignore sensational headlines to focus on the fundamentals. The following may seem like overly simplistic ones, but they work.

As I travel the country and speak about corporate intelligence and the economy, I get the same questions repeatedly. We could speak for hours on various components of the U.S. economy. But frankly, when we look at 2019, most of us simply want to know if 1) the U.S. and global economy will grow or contract; and 2) the most popular question: when’s the next recession?

Growth

The most prominent sources around the world (IMF, ECB, US FRB, Congressional Budget Office, and many others) are predicting 2019 GDP growth of between 2.3% and 2.5%. That’s after the impact of the Government shutdown, Brexit risk, China trade, and tariff impacts, etc. Compared to the 2.9%/3.0% estimated GDP growth rate for 2018, it’s hardly economic Armageddon.
The rumors are that global growth is also slowing a bit faster. Most sources have global GDP near 2.9% for 2019, that’s down from a forecasted growth rate of 3.3% in 2018. However, 2.9% in global GDP is above the 7-year average between 2011 and 2017 of 2.8%. Should the headline be a “global slowdown” or just simply “deceleration”?

Recession

Many people ask about the prospects of a 2019 recession. Already mentioned is that 2019 should usher in growth of 2.3%-2.5% despite several potential headwinds. Of course, there are always risks that significant trigger events could tip the scales and push the world into recession. It could come in the form of a major geopolitical conflict, major environmental or health-related event (rare), or an unexpected “popping” of a global asset bubble (real estate, debt bubbles, etc.).

Barring that, economic fundamentals are pushing recession risk beyond 2019. But, 2020 is not out of the question. Most analysts are concerned about typical consumer and business spending slowdowns that often accompany major presidential election cycles. We see it in economies around the globe, most recently with Mexican elections in 2018. It’s not solely a U.S. phenomenon, but we saw this happen in 2016 when private investment contracted year-over-year.

If private investment pulls back simultaneously in 2020 with: a slowing housing market (partially a result of rising interest rates), corporate margin pressures from accelerating wage costs and inflation, and political uncertainty that could include an end to tax reform and a favorable business regulatory environment; then the recession risk goes up quickly. Major elections breed uncertainty, and that uncertainty fosters a near-term pull-back in investment.

Private Investment

It would be difficult for the U.S. to slip into recession if Gross Private Domestic Investment (GPDI) is growing year-over-year. Although it accounts for just 16% of GDP, it has a remarkable linkage to recession risk. Since the 1940s, when GPDI has experienced a year-over-year contraction, the U.S. has gone into recession 11 out of 14 times. In the 3 “misses” when it dipped below zero, the U.S. was able to avoid a recession.

These ‘false positives’ were not bad outcomes!

At the end of Q3 (latest available data), GPDI was growing at 8.7% year-over-year. And since we only get this report quarterly, we look alternately at capex figures and they were growing at 6.5% year-over-year through November. This means that GPDI was likely also expanding in Q4.
The Congressional Budget Office predicts that private investment will still grow at a 4.1% year-over-year rate in 2019, even though it will decelerate slightly from 2018 levels.

There are two fundamental components of private investment: personal and corporate. Executive sentiment has a big impact on spending and investment. When executives are confident, they invest. When they face uncertain market conditions, they get conservative and investment activity can slow.

That is also why so much attention is paid to those factors that can negatively impact sentiment. At a corporate level, the government shutdown, Brexit, overactive Federal Reserve, and other factors build the “Wall of Worry”. Congressional fighting can also impact sentiment.

There are also structural elements that can change investment plans. Rising interest rates, tightening credit, lack of market/industry direction, and many other factors can cause derailments.

Consumers are interesting, in that they account for pieces of both private investment and consumption.

Much of what happens to the U.S. consumer starts with what happens to U.S. business. If executive sentiment is strong, they resist cutting investment and hiring. They take risks. They innovate and expand and help create the stimulus for wage growth.

Today’s Wall of Worry should be creating a cautious investment environment, but we just don’t see it yet in private gross domestic investment fundamentals.

Looking forward, recession risk mounts two years from now when forecasted GPDI dips to 1.9% in 2020 and just .9% in 2021. Just a slight hiccup in consumer spending, capex, inventory building activity, or a few other factors could tip us into recession during that time frame.

But, on a positive note, there are several factors that could pull us out of this deceleration trend over the next two years. Getting any number of trade deals put in place, a slow-adjustment period or “soft” Brexit, and reducing a few geopolitical headwinds might go a long way in creating a stimulus that carries forward.

Keith Prather is a Managing Director of Armada Corporate Intelligence. If you want information on a weekly basis like the article above, Armada publishes the Black Owl Report, an executive intelligence briefing that focuses on corporate risk. The Black Owl Report is just $7 a month and more information can be found here:
http://www.armada-intel.com/publications.