A weekly analysis of timely economic strategy issues from Wells Fargo Investment Institute.
Where Exactly Are We in the U.S. Economic Recovery?
- 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.
“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.
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.
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
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.
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.
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.
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.
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