Let’s Not Talk Ourselves Into Recession!

I’ve heard a lot of economists talk about how great the US economy is doing. I concede, it’s hard to disagree with that assessment. The unemployment rate is at a multi-decade low, wages are growing at a more respectable pace, and consumer confidence has been very high. In an economy so heavily dependent on consumer spending (consumer spending makes up nearly 70% of US GDP), these factors are undoubtedly supporting growth at a time when the rest of the world is struggling.
But what determines the economy’s future trajectory has less to do with the absolute level of key economic metrics and more to do with the change in those levels. For instance, today our unemployment rate is 3.7%. That means that pretty much anyone who wants a job can have one. True, many of the available jobs are low-paying, service-related jobs rather than relatively more lucrative manufacturing or technology jobs. But let’s put that aside for now. The decrease in the unemployment rate from a high of 10.0% in October, 2009, to the current level of 3.7% has been enormously supportive of the relatively steady economic growth we’ve enjoyed since the end of the Great Recession. In fact, according to statistics from the Bureau of Labor Statistics, the number of people working in the US has increased by 18.9 million since October, 2009. Needless to say, this kind of job growth is highly unlikely to repeat over the next ten years, especially since the current number of unemployed (which only includes those actively looking for work) is just 6.1 million. Could more folks be enticed to rejoin the work force as wages rise? Sure. The labor participation rate is still 4.3% below its all-time high of 67.3% in January, 2000. Getting back to that peak would bring an additional 11 million people back into the labor force. But we also must also consider the fact that some of the decrease in participation is structural due to waves of retiring baby boomers. Many of those folks won’t be going back to work. So at the very least, I think it’s fair to say that the growth in the number of employed people in the US is likely to slow materially from the relatively fast rates over the past 10 years. This is especially true if efforts to reduce immigration and/or deport illegal aliens continue.
With regard to wages, the story has been one of slow and steady growth from about 2% to a little over 3%. The acceleration in wage growth has been supported by labor shortages for certain types of jobs (health care workers and home builders, for instance). Given that the unemployment rate is so low and shortages for certain types of workers are likely to persist, it’s hard to see this trend reversing anytime soon. However, it should be recognized that the better wage growth in recent months has corresponded to a decrease in inflation. Lower inflation means that businesses have less power to increase prices. If labor costs, which are the largest expense category for most businesses, are rising but prices are not, this can lead to profit-margin compression. It’s conceivable that these wage-related margin pressures could be exacerbated by rising inputs costs related to the trade war with China. In some cases, these pressures on profitability could lead to reduced investment, less hiring, or even layoffs. At the very least, the wage pressures are something to watch.
Finally, we thought we’d take a look at the trends in consumer confidence. The two gauges of consumer confidence we track are produced by The Conference Board and the University of Michigan. Both gauges have been running close to historical highs recently, and these high levels of confidence have been one factor supporting consumer spending. In the chart below, we show the average of the two confidence metrics along with year-over-year growth in Personal Consumption Expenditures. You will see that confidence remains very high despite a weak reading for the University of Michigan survey for the month of August. At the same time, consumer spending growth remains fairly robust, even if down from the very strong rates of growth in mid-2018. So the data is pretty clear: confidence levels that might best be described as giddy have supported strong spending for a long while now. Other factors such as improved access to credit (looser lending standards) have contributed as well. But what happens from here? Is it more likely that confidence levels plow higher into uncharted territory, or will the readings begin to moderate based on all the negative news surrounding trade, economic weakness outside the US and political dysfunction? And if they do moderate, what does that do to the one reliable pillar of global economic growth – the US consumer?

Very often economists tend to dwell on the present while failing to look ahead. Economic forecasting requires not only a firm understanding of the current situation, but also how potential changes in various economic metrics might influence the established trends. From where I sit, the last remaining pillar of global growth – the US consumer – looks vulnerable, if only because it’s hard to see things getting much better than they currently are. Is it possible that some miraculous grand trade agreement will unleash a final burst of consumer exuberance? Could unemployment go to 3.0% and wage growth to 5% without seriously affecting business sector profitability? Sure, anything is possible. But economics is about weighing probabilities and determining the most likely outcomes.

Our biggest fear for investors right now is fear itself. If the US consumer gets spooked into retrenchment, it could be a tough holiday season for US businesses. But just as we must weigh probabilities as economists, we should not let a more pessimistic outlook cause us to make investment decisions from which it might become very hard to recover. Long-term investors should stay invested while maintaining somewhat of a defensive posture until the stormy seas subside.