New Year, Old Expansion
I ran a 5K up in Lowell, Massachusetts on New Year’s Day. Arriving at the starting line, I was brimming with optimism and resolution. I was motivated and the competition, close to a 1,000 assorted New Englanders, looked distinctly hung over. The start of the race was slow due to the size of the crowd but as soon as it thinned, I’d turn on the burners….and then….nothing.
Oh, I finished the race OK and not much slower than I had run last year. But for all my optimism and resolution, the truth is the machinery was just one year older, with a more pronounced rattle to the bones and rigidity to the muscles.
Many investors will have entered 2017 full of renewed optimism and Republicans, now fully in control in Washington, have a long laundry list of priorities they would like to tackle. Deregulation, repealing the Affordable Care Act, cutting corporate and personal taxes, increasing spending on defense, infrastructure and veterans’ affairs, cracking down on illegal immigration and playing tough on trade are all on the agenda.
However, this New Year’s agenda will have to contend with the realities of an old and slow expansion.
The current economic expansion has just entered its 91st month and by March it will become the third longest expansion since the year 1900. It has become a sort of “expansion emeritus”, gaining some grudging respect just by virtue of its longevity. However, as in the case of many professors emeritus, it cannot at this stage be expected to display much vigor.
There is little pent-up demand for vehicles left, although there is room for the housing industry to continue to grow. Inventories remain high while a strong dollar is sapping export demand. Meanwhile, both productivity and labor force growth remains weak. Without radical structural change, it will be difficult for this economy to sustain real GDP growth above a 2.0%-2.5% range.
Data due out this week should confirm this overall picture. Light-Vehicle Sales, at about 17.7 million units annualized for December, should look healthy but would still be slightly down from a year ago. International Trade numbers for November should confirm a significant weakening in the fourth quarter. On a brighter note, Purchasing Managers’ Indices for the manufacturing and services sectors should look strong, but still not strong enough to indicate an upshift in economic momentum.
Friday’s Employment Report should tell a similar story, with solid payroll job gains of between 150,000 to 200,000, and a rebound in wage growth from a weak October. However, we expect the unemployment rate to remain at a low 4.6%, highlighting the continued lack of supply of easily-employable workers.
Overall, our models are tracking an annualized real GDP growth rate of only 1.0%-1.5% for the fourth quarter, which, in turn, suggests productivity growth of just 0.6% year-over-year. In other words, an economy stuck firmly in second gear.
Of course it may well be that less regulation, lower corporate and personal taxes and significant fiscal stimulus will boost demand. It could also be the case that a relaxation in immigration laws or rising wages boosts labor supply.
However, for now, we still don’t know which regulations are likely to be repealed and, more importantly, we don’t know the extent of any possible cut in corporate taxes or the exact nature of any change in the structure of corporate taxation. Without this information, many firms may postpone decisions to expand capital spending. It could be that deficit hawks in Congress block significant fiscal stimulus. It is also possible, given campaign rhetoric, that the incoming Administration and Congress reduces rather than increases immigration or becomes embroiled in a trade war.
For the moment, then, while equity markets have rallied on the assumption of stronger economic growth and higher corporate earnings, the economy itself may not yet be ready to deliver.
If I put in the miles and follow all the other items on my training agenda, I may well be running races faster in July than in January. However, that is a fairly big “if”. Similarly, if the incoming Administration and Congress can focus on those issues that help business grow, the economy later this year and in 2018 may well justify further gains on top of the recent stock market rally. But that is also a big “if” and, for now, investors may be wise to curb their enthusiasm until we have stronger evidence that Washington will actually implement a pro-growth agenda.
Chief Global Strategist