Economic expansions rarely last more than 8 to 10 years without a recession. Stock markets almost always have greater than 20% corrections associated with each recession. However, it’s naive to assume expansions and contractions have expiration dates. Looking for the global economy to engage in a classic contraction with spiking unemployment and crashing equity values are typically preceded by excessively tight credit conditions to quell an overheating economy. After 8 years of economic expansion and a soaring stock market, the consumer has record low debt service needs, factories still have tons of excess capacity, inflation remains elusive and credit risk is historically low.
Banks Are Providing Credit
While auto loans have elevated delinquency rates, mortgage and credit card failures are modest and banks are not tightening anywhere close to alarming levels yet. For the past 7 years banks have been relaxing their loan restrictions to small businesses to the excess liquidity in a low risk – slow demand environment.
Banks are well capitalized this cycle and inter-bank borrowing credit risk is perceived to be very low. Let’s see a tick above the 2012 and 2016 highs before paying attention to this measurement. A breach of 1% would be a concern, but o.4% is not a problem.
The Fed is worried about inflation – so they say – and have telegraphed an aggressive schedule of rate hikes the next 2 years. What’s the hurry? Their core Personal Consumption Expenditures (PCE) is only 1.8% and the key wage rate reveals an historically subdued 2.5% inflation. Job openings and skilled labor shartages are extremely high, yet wage inflation remains low. A lack of skilled labor will limit total economic growth and keep the marketplace providing credit until wage rates move into the 3 to 4% range. As long as the yield curve retains its positive slope the marketplace will ignore serious inflation worries.
Federal Debt burdens are destined to continue growing at alarming rates for years to come, yet aging boomers in a low yield era have kept debt stress at comfortable levels. Even with very low mortgage rates we would expect overall debt to income ratios to rise for a couple years before household spending peaks. Rising home ownership from Millennials and higher interest rates on debt would be normal before an economic cycle top.
While at PIMCO way back in 2009, the Bond King Bill Gross presciently talked of the New Normal with historically reduced GDP growth rates. The benchmark since the Great Recession has been about 2%. The 1st quarter of 2017 came in at just 0.7%. Hardly an omen of an overheating economy in need of aggressive credit tightening. If such a weak number carried into the 2nd quarter then Deflation would become the concern instead of the Fed’s focus on inflation.
The 2 main drivers of GDP for many years have been personal consumption and inventories. The consumer is 69% of our economy and fortunately he has come through consistently with almost 2% added to the GDP numbers. At just 0.2% growth, this was one of the lowest spending rates by US consumers since the later part of the 2009 recession. Unless one believes the next recession is on our doorstep, we would expect this major driver to bounce back in coming quarters barring an exogenous event.
While inventories can be volatile, the odds favor an improvement here as well. Excessive auto loans and a saturation of expired leasing inventory may reduce car sales and keep inventories subdued another quarter, but a return to the New Normal of 2% will be a magnet.Should Corporate tax cuts, infrastructure spending or US repatriation of overseas capital occur then perhaps we can boost our GDP closer to 3% for a year or so. Otherwise annualized rates of 2 to 2.5%GDP are the best we would expect for now.
The many charts discussed paint a picture devoid of economic cycle metrics from over heating. Of course a financial panic such as 1987 when the economy remained healthy is something to be vigilant for. The 40% rally in 1987 and the crazy valuation multiples of the late 1990’s would require a much larger rally than we have seen since Trump was elected. With Blue Chip Tech leaders Facebook, Google and Apple priced as value stocks and the very strong S&P Index earnings growth this quarter, we don’t see alarming speculation based upon the technicals or fundamentals. Long term equity investors remain 95% invested basis S&P 500 Index.