The U.S. economic recovery and expansion has now lasted more than a decade, which is historically ‘long in the tooth’. With each passing month, and despite how well the major stock market indices may be doing, worries about a slowdown or next recession become harder to suppress.
The following are some of the yellow flags pointing to potholes in the road ahead. When warranted, countervailing positives have been added.
(1) Running Out of Track for the Stimulus Train
At present, it’s the absence of something special to look forward to that is significant. Heading into 2018, executives throughout the U.S. were eagerly anticipating the steep cut in the corporate tax rate, from 35% to 21%, and several other business-friendly initiatives (i.e., incentives to repatriate money from overseas, etc.). There’s nothing implying a similar upbeat impact on the horizon today.
The Trump administration has floated the idea of a big middle-class income tax cut. A formidable stumbling block, however, has emerged. The estimated federal deficit in the current fiscal year, made worse by the corporate tax cut, will reach -$1 trillion. Washington’s total debt is -$22 trillion and climbing. Personal income tax relief would most likely further exacerbate an already troubling situation.
Interest rates are at historic lows. When companies and individuals seize the opportunity to refinance previously arranged and more expense debt, that’s good. When they load up on additional debt to permit more spending, however, that may be stimulatory in the short term, but it’s fraught with peril longer term. Interest rates will eventually increase and when they do, the rise in carrying costs will be crippling for many, including the public sector.
(2) Jason, Freddy Krueger and the Twin Deficits Problem
Before the 2007-2008 recession, there was a great deal of conversation in media and political circles about the ‘twin deficits’ problem. The ‘twins’ being referenced were trillion-dollar shortfalls in both government finances and foreign trade.
With the onset of the recession, a pronounced drop in imports helped reduce the trade imbalance by more than half. With respect to the public purse, belt tightening through such means as ‘sequestration’ diminished, but did not eliminate, the excess of expenditures over revenues.
Like the villains who can never really be dispatched in horror movie franchises, ‒ think Jason of Friday the 13th or Freddy Krueger from Nightmare on Elm Street ‒ the double deficit problems are back. The only reason they’ve been escaping under the radar is because there are so many other competing distractions.
(3) The Blow to International Supply Chains
China’s share of the U.S. ‘goods’ trade deficit has been between 40% and 50% each month over most of the past several years. The Trump administration launched tariff action to reduce that gap, with Beijing swiftly retaliating in kind. The U.S. wants more access to the Chinese marketplace, plus measures to protect proprietary intellectual property.
Promises of pending agreements to resolve the U.S.-China trade war have been made frequently, only to prove insubstantial soon afterwards. The agricultural sector and manufacturers dependent on exports have seen sales and shipments sink. International supply chains have been disrupted and there is confusion about how much re-adjustment will eventually be required.
Meanwhile, the U.S. merchandise trade deficit really hasn’t improved at all. In July, it stood at almost -$900 billion.
(4) A Wonky Interest Rate Environment
Two of the most widely discussed warning signs relate to interest rates. A phenomenon known as an ‘inverted yield curve’ occurs when short-term interest rates rise above long-term interest rates. In the past, this has almost always foreshadowed a recession. During much of 2019, the U.S. yield cure has either been close to or has exhibited inversion.
But the reason for short-term interest rates rising above long-term yields has been different this time. The Federal Reserve initially launched the latest round of ‘federal funds rate’ increases to ‘normalize’ carrying charges or return them to more usual levels. The Fed hasn’t been desperately trying to rein in inflation, like it has often been required to do in the past. Inflation has been passive for a surprisingly long time.
To back away from yield curve inversion, the Fed has recently instituted two rate cuts of 25 basis points each, where 100 basis points = 1.00%. There’s an expectation of more monetary easing to come. Unfortunately, this points to the possibility of an anomaly that has gripped much of the banking sector in Europe, negative interest rates. Some banks overseas are paying individuals and corporations to take out loans. These are unprecedented times. Surely, this can’t be a viable business model for the financial sector.
(5) Manufacturing in Contraction
For August 2019, the Purchasing Managers Index (PMI) of the Institute of Supply Management (ISM) dropped below 50.0% for the first time since August 2016. The latest month’s PMI fell to 49.1% from 51.2% in July. A PMI reading above 42.9% but below 50.0% indicates that while the overall economy is expanding, the manufacturing sector is contracting.
Furthermore, nine of the PMI’s ten sub-indices also recorded values below 50.0% in this year’s August. The biggest month-to-month drops occurred in the ‘new orders’ index, moving from 50.8% to 47.2%; the ‘employment’ index, retreating from 51.7% to 47.4%; and most dramatic of all, the ‘new export orders’ index, sliding from 48.1% to 43.3%. Respondents to the PMI survey expressed concern about the negative fallout from the U.S.-China trade spat.
The ISM also calculates a non-manufacturing index (NMI) each month and it’s been moving in counterpoint to the PMI. In August, the NMI performed admirably, climbing to 56.4% from 53.7% in July. Among the NMI’s sub-indices, the standout month-to-month gains were recorded in ‘business activity’, rising to 61.5% from 53.1%, and in ‘new orders’, shifting to 60.3% from 54.1%. The NMI’s ‘new export orders’ sub-index, though, declined to 50.5% from 53.5%.
(6) Production-line Capex has Stalled
President Trump often expresses his fond wish for a resurgence in American manufacturing. Signs of inertia in the sector, however, continue to be readily apparent. The latest (July 2019) measure of capacity utilization in U.S. manufacturing taken by the Federal Reserve places it at just above 75%, and below where it was a year ago.
Government measures to stimulate capital expenditures, or ‘capex’, won’t have much success when utilization rates are so low. There’s no need to expand square footage when additional output, if it is required, can be easily satisfied with existing assets. Capacity utilization in a sector needs to rise to at least the mid-80% level for member firms to begin considering adding to footprints or investing in more automation.
Plus, there’s the shot across the bough of management-labor relations made by the 50,000 striking workers at General Motors. To increase profits and please investors, GM has been closing plants in the U.S. and Canada that have been assembling the automaker’s less popular and mainly passenger car models. Primary among their demands, GM’s workers want guarantees of more job security.
Also warranting mention is the fact that compensation improvement in the U.S. has been okay, but not spectacular. Year-over-year hourly and weekly wage growth has been stuck in a +3.0% to +4.0% range. The GM strike may be a harbinger of more labor unrest to come. There are always upsetting economic ramifications from big labor disputes.
(7) Births Down, Deaths Up
U.S. population growth is slowing. In economic theory, there’s a key proposition that says having more people leads to more consumer spending, a good thing. (Of course, the extra people must also have jobs and incomes to allow additional spending.) America’s population growth rate from mid-2017 to mid-2018 dropped to 0.62%, its slowest pace in 80 years, dating back to the late 1930s.
The ‘natural’ increase in population is being held back mainly by a notable absence of babies. The number of U.S. births in 2018, at 3.79 million, was the lowest in 32 years. 2018 was the fourth straight year of birth declines, according to statistics from the Centers for Disease Control and Prevention.
Moreover, there are now 1,728 births per 1,000 women during their entire lifetimes, also down from prior years. This is often represented as a ‘fertility rate’ of 1.73 births per woman of child-bearing age. The replacement fertility rate, ‒ i.e., the rate needed to keep the population steady, with no help coming from international migration, ‒ is 2.1.
Also serving to render population growth more sluggish has been a recent increase in the ‘age-adjusted’ death rate. Augmenting the standard causes of death from sickness, accidents and suicides, there has been a surge in drug-related mortalities. Overdoses arising from the usage of too-potent fentanyl and illicit or prescription opioids have more than doubled over the past decade.
(8) Cuts in Immigration and Internal Migration
Approximately half of U.S. population growth is now reliant on immigration. A figure of about 800,000 legal immigrants per year has been the U.S. norm. But sentiment concerning immigrant arrivals, both legal and illegal, has taken a reverse turn in Washington. The prospects of bringing in younger workers to help support an aging population in America (i.e., due to ‘baby boomers’ growing older) has dimmed.
Nor is a warm welcome presently being extended to refugees. And foreign student enrolments are down to such an extent that insurance policies are being offered to protect some institutions against severe tuition fee losses.
Also, on the demographic front, there is no longer the frenzied internal migration in the U.S. that there once was. In the 1950s, more than 20% of Americans changed residence each year. In the latest time frame for which data is available, 2017-2018, the ‘let’s-relocate’ proportion was only 10.1%. The 10.1% mobility ratio was the lowest since World War II.
Fewer people on the move is one of the reasons housing starts since the 2008-2009 recession have not fulfilled their expected promise. A trend line placed through historical housing starts levels would suggest an annual figure of 1.6 million units. Instead, they’ve struggled each month to stay steady at 1.3 million units, seasonally adjusted and annualized (SAAR).
August’s residential building permits number, however, suddenly burst above 1.4 million units, giving rise to the hope that the homebuilding sector has finally broken out of its lethargy.
Graph 1: U.S. Monthly Residential Building Permits
Seasonally Adjusted at Annual Rates (SAAR)
(9) Jobs Growth Decelerating
The average monthly increase in U.S. employment through August of last year was +235,000 jobs. The comparable figure for this year has been +160,000, down by one-third. The nation’s exceptionally low unemployment rate of 3.7% is making it harder to sign-up workers.
Year-over-year jobs growth in nearly every major industrial sector is now slower than it was at the same time last year. In other words, there has been a deceleration in hiring.
By major industrial sector, manufacturing year-over-year employment has downshifted from +2.1% to +1.2%; construction, from +5.0% to +2.4%; retail trade, from +0.1% to -0.5%; ‘transportation and warehousing’, from +4.5% to +2.2%; ‘professional and business services’, from +2.4% to +2.1%; and government, from +0.6% to +0.4%.
The two major exceptions have been ‘education and health’, moving up to +2.4% in August 2019 from +2.0% in August 2018, and ‘leisure and hospitality’, going to +1.9% from +1.7%.
(10) Construction Activity Waning
ConstructConnect’s grand total construction starts statistics through August 2019 have been -3.3% year over year. There’s been a marked shift in the composition of this year’s starts towards ultra-large projects, a.k.a. mega projects of $1 billion or more each. The total value of mega project initiations in 2019 so far has been $92.5 billion, much higher than 2018’s comparable figure of $35.4 billion.
Excluding mega projects from the picture, ‒ in other words, focusing more on medium and smaller-sized undertakings, ‒ the percentage change in starts two-thirds of the way through 2019 versus January-August 2018 has been -15%.
Confirmation of a general easing in enthusiasm for construction can also be found in the latest ‘billings index’ results from the American Institute of Architects (AIA). The Architects Billing Index (ABI), which monitors the demand for design services, pulled back to 47.2 in August from 50.1 in July. A number less than 50.0 indicates a decrease in billings. The ABI has been below 50.0 three times this year.
The ‘inquiries’ sub-index (54.5) of the ABI has also been retreating, although it remains above 50.0, and the ‘design contracts’ sub-index (47.9) has sunk to its lowest level since the recession. Regionally, only the West (51.2) has an ABI that’s still above the halfway-to-100.0 mark.
(11) Geopolitical Hot Spots
Conflict among nations, that sometimes bubbles over into more than just words, is seemingly an ever-present danger. But the current degree of political acrimony around the globe seems even more fractious than usual. Saudi Arabian oilfields have proven vulnerable to drone attack, whether launched from Yemen by Houthi rebels, or as is suspected by U.S. intelligence, from sites in Iran.
The U.S. has withdrawn from the international agreement designed to halt Iranian nuclear weapons production and has ratcheted up sanctions on trade with that nation. It’s also demanding that other countries (e.g., India) restrict their dealings with Iran. In response, Iran has taken several military actions (e.g., seizure of tankers) to disrupt the flow of oil from the Middle East. Tensions could escalate further.
In the Pacific sphere, protesters in Hong Kong are refusing to be tamed by mainland China. No doubt the patience of the central government is being sorely tested, but with the public relations disaster of Tiananmen Square still fresh in many memories, will Beijing dare risk a severe crackdown? Also, North Korea, to the chagrin of the U.S. and to the considerable alarm of Japan, is continuing to test its missile delivery capabilities.
(12) Brexit and the 2020 Presidential Campaign
Across the ‘Atlantic pond’, whether the United Kingdom will withdraw from the European Union remains an open question. If there is a ‘Brexit’, will it be ‘soft’ (i.e., made easier by negotiated trading arrangements) or ‘hard’ (i.e., no special deals)? Will there be another vote on Brexit, now that P.M. Boris Johnson’s maneuver to prorogue, or temporarily suspend, Parliament has been ruled illegal by the courts?
Combine Brexit with the ongoing U.S.-China trade conflict and the shaky state of some European banks, especially in Italy, and world trade continues to be restrained by a surfeit of uncertainty.
There’s also the distressing state of U.S. politics ‒ at best a distraction; at worst, a toxic stew in which no legislation beneficial to the nation as a whole can be passed due to rancorous partisanship. With impeachment hearings about to begin, the 2020 Presidential election campaign promises to be quite an unseemly spectacle.
(13) How ‘Bout this Weather?
There’s one final unknowable to worry about, the weather. Along the Gulf Coast and the Atlantic shoreline, severe weather events have been cutting vast swathes of destruction ‒ to plant, animal and human life and to man-made structures ‒ with increasing regularity.
On the West Coast, it’s been wildfires that have devastated enormous acreages and drawn widespread press coverage.
Most scientists chalk these events up to climate change and a warming planet. Better crisis prevention preparation will help, but there will be no easy-to-implement complete fixes.
Alex Carrick is Chief Economist for ConstructConnect. He has delivered presentations throughout North America on the U.S., Canadian and world construction outlooks. Mr. Carrick has been with the company since 1985. Links to his numerous articles are featured on Twitter @ConstructConnx, which has 50,000 followers.
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October 18, 2019, Globe & Mail Centre, Toronto – Learn more below.