Global Perspectives

A weekly analysis of timely economic strategy issues from Wells Fargo Investment Institute.

January 17, 2018

Peter Donisanu, Investment Strategy Analyst
Craig P. Holke, Investment Strategy Analyst

Where Exactly Are We in the U.S. Economic Recovery?

Key Takeaways

  • In December, we wrote about market-based measures of the business cycle and recessions. But what is the economic data telling us today?
  • Household spending, business investment, and labor-market measures are consistent with the tail end of an economic expansion, but we believe a recession is not likely imminent.

What It May Mean for Investors

  • We believe that investors waiting on the sidelines in anticipation of an imminent U.S. recession may miss out on positive performance in U.S. stocks this year.

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“Is the U.S. economy headed for a recession—and if not, where are we in this cycle?” This is the single most common macroeconomic-related question fielded by our team. For investors, such a question is important because the answer to it (more often than not) fundamentally guides subsequent investment decisions. Indeed, our strategy guidance is predicated on having a firm grasp of our position in the U.S. economic recovery. In today’s report, we review the broad trends that we believe put the U.S. economic expansion in a maturing phase with no recession imminent.

Chart 1. U.S. appears to be near the beginning of the late stage of the cycleChart 1. U.S. appears to be near the beginning of the late stage of the cycleSource: Wells Fargo Investment Institute, January 5, 2018.

Where are we in the economic cycle?

In December, we discussed the concept of the business cycle and looked at some of its market-based measures.1 Such indicators broadly tell us how market participants are interpreting the U.S. economy. What stage of growth does our team believe the U.S. economy is in? As we noted in last month’s report, we believe that the U.S. economy is at the start of (or close to) the third phase of the expansion (Chart 1). Further, we find that measures of household spending, business investment, and labor-market conditions are consistent with an economy that is still expanding, yet likely entering (or in) the late, and final, growth phase.

With this view in mind, some investors then have asked “when is the next recession coming?” Barring unforeseen circumstances, we believe that tax reform is likely to support economic activity in the near term, and we do not expect a U.S. recession this year. At this point, a contraction in 2019 also seems unlikely. Further, statistical analyses conducted on household spending, business investment, and labor-market indicators suggest that a turn in the business cycle typically occurs 12-18 months following some sort of excess evidenced as a peak or trough in these specific measures. With that said, a recent review of these indicators provides little evidence of stretched conditions that have historically preceded recessions.

Chart 2. Since the last recession, U.S. household savings is down while cumulative revolving credit is marginally higherChart 2. Since the last recession, U.S. household savings is down while cumulative revolving credit is marginally higherSources: Wells Fargo Investment Institute, Bloomberg; January 4, 2018. Note: Years in both panels reflect end-dates of prior business cycle expansions. Data in the right panel reflects total revolving credit growth during the business cycle referenced.

Business investment

Late last year, a key measure of U.S. manufacturing and services sector sentiment rose to its highest level in more than a decade.2 In an environment of rising business optimism, it is important to consider whether excesses are evident in the business sector of the economy. One way to measure excesses in the business sector is to look at how much firms are spending on capital investment relative to previous cycles. To that end, broad business investment per quarter is up 16.5% from the previous high set in 2007 (Chart 3, left panel).3

Chart 3. U.S. business investment is up from the end of the last recession, but is not at extremesChart 3. U.S. business investment is up from the end of the last recession, but is not at extremesSources: Wells Fargo Investment Institute, Bloomberg; January 5, 2018. Note: Calculations in left panel chart reflect growth in business investment from peak to peak (March 31, 2001 and December 31, 2007) and peak to current levels (March 31, 2008 and September 30, 2017).

Even at nine years into the current economic expansion, spending levels are lower than they were during the cycle ending 2007. At a more granular level, net investment (the value of investment that exceeds simply replacing obsolete equipment), shown in the right panel of Chart 3, indicates that cumulative spending is higher than in 2000, yet below the previous peak in 2007 (this is using the most recent data, through 2016). In other words, firms are opening their pocketbooks to new projects, but when taken together, total investment and net investment data have yet to suggest excesses in business investment.

Labor market

U.S. economic expansions typically end 12 months after labor markets enter a period of high full-time employment and low part-time and temporary employment. Yet, according to a recent government survey, the number of individuals identifying themselves as being employed “part-time for economic reasons” remains well above previous norms (Chart 4).

Similarly, the total number of temporary workers in the U.S. is at a 30-year high. An argument could be made that if labor-market conditions were indeed “full,” there would be fewer individuals employed either in part-time or temporary posts. Indeed, while the headline jobless rate is encouraging, the labor market today is not as “full” as it has been in previous cycles. This suggests to us that labor-market conditions are not yet stretched.

Chart 4. Part-time and temporary worker levels not yet signaling “full employment”Chart 4. Part-time and temporary worker levels not yet signaling full employmentSource: Wells Fargo Investment Institute, Bloomberg; January 8, 2018.

Investment implications

It is hard to make a compelling case that stretched conditions exist in the U.S. economy today. While no one measure is a perfect indicator of economic excesses, we do not see recession signals in household and business spending, or in labor-market trends. When excesses do become evident (peak spending and investment, and full employment), our historical analysis suggests that the end of the current expansion could occur 12-18 months thereafter.

We do not anticipate any changes to our view that a recession is not imminent. Yet, we are watching some scenarios that could change our conclusion. In particular, policymakers at the Federal Reserve (Fed) recently affirmed their forward rate guidance, but policy missteps remain a key risk for financial markets. Leadership changes at the Fed, combined with the potential for a “surprise” in headline inflation, could prompt policymakers to raise rates faster than markets currently expect. If rates and inflation were to accelerate unexpectedly, the outlook for economic growth could dim.

From an investment perspective, we believe that investors waiting on the sidelines in anticipation of an imminent recession may miss out on likely positive performance in U.S. stocks this year. A robust economic expansion, combined with tax reform, could extend the corporate earnings recovery that is already underway.4 While valuations in U.S. equities have become richer, an uptick in tax-reform-related capital spending and lower tax liabilities could precipitate a boost in bottom-line corporate earnings, which ultimately is favorable for equity prices.

Economic Calendar Economic CalendarSource: Bloomberg as of January 10, 2018.

1 Global Perspectives: “Recession Indicators Agree—the Expansion Continues”, December 19, 2017.
2Institute for Supply Management (ISM) Economy Weighted Purchasing Managers’ Index (PMI).
3Private fixed investment (excluding residential construction spending).
4Global Perspectives: “Is Global Economic Growth Coming or Going?”, November 21, 2017.

Risk Considerations

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers. Investments in equity securities are generally more volatile than other types of securities.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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