Often when US Presidents can score a single major legislative accomplishment during their tenure it’s enough for the history books. Reagan had the massive Supply Side tax cuts, Clinton passed the North American Free Trade Agreement (NAFTA) and Obama’s landslide election mandate gave us Obamacare. Trump made history with his historic corporate and personal tax cuts in 2018. While his major tax changes may be worthy of being notable legislation, it’s increasingly likely that the self proclaimed Tariff Man will be remembered for his plethora of prolific Trade deals. We pass no judgement upon any President here, but the Trump trade deal steamroller has now secured new deals with Mexico, Canada, South Korea, Japan and now a partial deal with China. With the Brexit Bombshell ushering in a Boris Johnson mandate we would expect yet another major new trade deal between the UK and Trump in 2020 once Brexit is formalized. While economists add a fraction of a percent to US GDP for these changes, we believe many underestimate the vital importance of economic sentiment in propelling capital spending and personal consumption. Assuming these recent successes on the trade front are codified and enforced, they should provide a higher than consensus boost to the economy in 2020. When the Phase One China Trade Deal is formalized in January along with the USMCA (NAFTA II) deal with Canada and Mexico, then we will see how correlated business sentiment is with actual business activity and economic growth. When Trump was elected there was an immediate related surge in economic optimism along with a commensurate jump in the industrial economy within a few months. Will these trade deals along with a newly accommodative Fed be enough to turn the sagging manufacturing economy upward? We’ll revisit this in the Spring.
Manufacturing orders surged when Trump was elected and fell when his trade war kicked in. While they have been flat for the past 18 months there could be some pent up order demand as confidence returns with the cessation of tariff battles and persistent economic threats curtailing industrial spending.
Yet Recession Ruminations Remain
Since April 2019 when everyone heard the term inverted yield curve (short term yields above long term) the widely accepted conclusion was simply that it equals an economic Recession, no matter what, since such occurrences preceded past contractions. Even though our economy (GDP) has held onto the new normal 2% growth rates, far from a contraction, prominent money management companies have recently continued warning of a clear and present danger of a US Recession in the first half of 2020. Sounds ominous! Many forecasters and their previously infallible economic recession probability models have been prognosticating a long overdue contraction in our GDP for the past couple of years. Among the reasons cited for trouble in River City forecasts aside from the inverted yield curve is unemployment being too low or trade war with China curtailing global trade. (1) A small temporary yield curve inversion occurred in a low inflation strong economy with falling interest rates – Bullish. (2) Unemployment at 3.5% hitting new 50 year lows is a sign of a healthy economy with unfulfilled demand – Bullish. (3) The ever escalating Trade War between the worlds largest economies is no longer a headwind to growth and may trigger a pent up expansion in global exports in 2020 more typical of economic bottoms.
Many indicators related to momentum in the industrial economy were nearing worrisome levels recently as the normal 3 to 4 year cycle low ends. Leading indicators are among the road signs approaching worrisome levels. We caution that this new world of tight labor and commensurate elevated levels of consumption can translate into less meaningful flat readings in the leading index. Looking at some leading economic components: How much more can hourly workweeks and employment rates grow when we have full employment? How much faster can home building grow with a secular labor shortage? How much more can stocks appreciate given the enormous gains of the past decade? These constraints to growth are not signs of a contraction due to overheating. Nonetheless we would raise the Yellow Flag on the economy should this leading index measure fall much below current levels.
Throwing some of these leading indicators into a Recession Probability Model we can see how much the 2019 manufacturing contraction has impacted the odds of a broader economic (GDP) constriction. We would estimate a warning zone to watch is between 10 and 20, above which we would become more concerned.
While Guggenheim Partners, Morgan Stanley and other prominent wealth managers have been calling for an early 2020 recession, many of the same Bears are now shifting with the tides and talking of a Global recovery in early 2020. The resilient consumer and recent green shoots in the industrial economy continue to keep us in the Bull camp on the economy and stocks. Economic cycle lows we have been forecasting have essentially arrived, central banks are stimulative, the fully employed consumer has a strong balance sheet with above trend wage growth. The only modest short term economic risk currently centers on a temporary GDP hit from reverberations of the Boeing 737 Max production shutdown. The upside here is that Boeing “will” eventually return to full production causing a pent up surge in activity. The economic nadir around 2% GDP growth may be complete here and a further expansion phase through 2021 may be underway soon.