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With a ratcheting up of Chinese/American trade rhetoric and the market’s 800 point swoon over the last several days, there are serious questions about what’s going on. We’ve been consistent over the last year or so – and especially over the last several volatile quarters – that a recession is not in the offing, that the market drops were not indicative of an economic downturn. We want to reaffirm that conclusion, but at the same time offer our thoughts on what is actually going on and where the risks of recession lie.
First, some current data which we believe supports a positive economic conclusion.
Today’s (August 15th) retail sales report shows that consumer spending increased 0.7% in July, which beat forecasts, and represented the fifth consecutive monthly increase.
“Core” sales, which exclude the most volatile sectors, were up 1.0% in July and are up 4.8% from a year ago.
Also today, nonfarm productivity rose at a 2.3% annual rate in the second quarter, beating the consensus expectation of a 1.4% increase. The annualized 2-year average is a 1.7% increase. This is the fastest two-year increase we’ve seen since 2011.
On a more general level – but nonetheless important – wage level continue to move up, consumer balance sheets look healthy, and serious (90+ day) debt delinquencies are down substantially from post-recession highs.
The bottom line is that the consumer is not in trouble economically.
On the industrial front, there has been some slow down in growth rates, but the sentiment remains strong. The Philly Fed Index, a measure of East Coast factory sentiment, dropped to +16.8 in August from +21.8 in July, but the Empire State Index, which measures factory sentiment in the New York region, continued its rebound, rising to +4.8 in August from +4.3 in July. Both of these readings beat consensus expectations and signal continued optimism.
In the real estate sector, the NAHB index, which measures homebuilder sentiment, rose to 66 in August from 65 in July, matching its 2019 high.
These data points clearly support an expectation that economic growth will continue, but we fully acknowledge that the rate of that growth may be slowing. The reduction in growth rates, we believe, is being driven by uncertainty over the Chinese/American trade dispute. But this is distinctly different than saying the outcome of that dispute is a foregone negative conclusion. In fact, we believe that the eventual outcome may be decisively positive.
Without attempting to venture into politics, most economic commentators believe the record is undeniable that China has stolen intellectual property, misappropriated technologies, and manipulated its currency. These are all bad for the rest of the world long-term. They may be helpful to China (that’s why these practices have been implemented), but they are bad for other countries around the world. Ultimately, everyone is better off if the world trading system is fair and property rights are respected.
The current administration has decided to address this issue. We can disagree with the manner in which negotiations are conducted, we can grimace at the content of tweets, and we can dislike the volatility which is a result. But to be fair, we have to ask what might be necessary to bring about the proper long-term resolution, namely a fair and enforceable trading system.
As one prominent economist phrased it, “… if Trump’s tariffs are going to have their intended effect, namely forcing China to lower its trade barriers and respect intellectual property rights, then the Chinese are going to have to be very worried bad things are going to happen to their economy if they don’t make a deal with Trump. It’s also true that for the Chinese to take Trump seriously, just about everyone else needs to be worried that Trump is out of control and the global economy is headed for a fall. If we aren’t scared, the Chinese never will be.”
We may not like this, but it may very well be necessary. Now if we believed that the current administration was going to initiate a full-blown trade war with the world, or was to engage in blatantly broad protective one-sided trade policies, we would predict that recession would be the inevitable result. But we do not believe that is what’s going on.
We believe that what’s going on is “hardcore Jersey-style construction” negotiations (no insult meant to New Jersey or construction workers). Again, we may not like it, but that’s what it seems to be – hardball tactics meant to bring the Chinese into serious negotiations and compromises.
Returning to the homeland, the US economy remains sound. It has been growing faster than the rest of the world because of the tax and regulatory reductions which made doing business in the US potentially more profitable than doing business elsewhere. As it is, we project the economy will continue to grow and the markets will recover. We even believe that we would avoid recession if the Chinese economy goes into a recession; we are less dependent on selling stuff to China than China is dependent on selling stuff to us.
Could a full-blown trade war with lots of other countries throw us into recession? The answer is yes. But we do not perceive this is the administration’s goal, nor will it be the result of its current policies.
We are witnessing the fallout from tough negotiations which many economists believe need to occur. It bears repeating that if the Chinese leaders do not come around, more of their economy is dependent on exports to us, than our economy is dependent on exports to them. Our growth may slow, but there is no reason that a recession needs to happen.
Market volatility will continue, and emotional turmoil is a natural result. But the long-term prognosis for our economy, and for the markets, remains positive and strongly so. It may take a while, but today stocks are substantially undervalued and collectively represent a significant opportunity.