Breathe easier, America. This New Year, the economy hits the ground running.
This isn’t the surge-and-slip recovery we’ve gotten used to since the Great Recession. We’ve got low unemployment, low inflation and low interest rates. We’ve got high growth, high stock prices and high confidence.
Economic news repeatedly surprises the experts by beating their expectations.
The rest of the globe is doing well too, thank you very much, in what economists label as “synchronized” growth that’s showing “a rare bout of synchronicity.” In short, it’s good all over at the same time.
Goldman Sachs declares the current state of the global economy “As Good As It Gets.”
“Finally in 2017, the global economy broke out of the doldrums and put to rest a lot fears people had about secular stagnation,” said IHS Markit chief economist Nariman Behravesh.
Secular stagnation is how economist Larry Summers describes the malaise that has plagued the recovery for years. In Summers’ view, several factors including an aging population but mostly a stronger tendency to save and weaker inclination to invest would persist as headwinds.
Still, there are risks to these good times.
▪ The economy could begin to overheat, given that Washington just served up a $1.5 trillion tax cut and eyes a spending push when most economists argue the economy doesn’t need a push.
▪ The Federal Reserve, which raised interest rates three times in 2017 including this month, may decide to hit that brake on the economy harder in 2018.
▪ Politics holds threats, from risks to world trade via free trade negotiations in North America and England’s negotiated exit from the European Union to confrontations with North Korea.
The good news is that economic growth is robust and broad enough to keep the expansion going. Says forecaster Behravesh, it would take “one heck of a shock” to send this economy into recession.
Wells Fargo Securities economist Mark Vitner looks at the long economic recovery from the Great Recession and says it has been running backward.
Usually, economies pull out of recessions with vigor. This recovery, already long in the tooth by historical standards, has posted its most vigorous stretch of growth in the last nine months.
The nation’s Gross Domestic Product grew at a 3.1 percent pace in the second quarter of 2017. It grew 3.2 percent in the summer quarter, and strong consumer sales around the holidays mean that growth may again have reached 3 percent during the final three months.
Investment strategists Bruce Bittles and William Delwiche at Robert W. Baird & Co. stood apart from the consensus a year ago by predicting “protracted” 3 percent economic growth ahead. Moreover, they saw the economy would switch from disappointing most predictions to beating them.
Annual growth had been averaging 2.1 percent starting in 2010. Most estimates show 2017 will measure out at 2.2 percent to 2.3 percent growth, though that depends on how the last three months come out.
If the economy posts three consecutive quarters of 3 percent growth, says a report from Gluskin Sheff + Associates, it would be for the first time in 12 years. It also is fueling forecasts for growth in 2018 to reach from 2.4 percent to 2.8 percent.
“Growth has not only strengthened, it is broadening,” Vitner said.
And that’s despite of one limiting factor – labor.
“The economy could be a lot stronger today if we could find the workers,” Vitner said. “There are a lot more jobs open in manufacturing and construction than we can find qualified workers to fill them.”
The U.S. unemployment rate, now at 4.1 percent, is expected to fall further in 2018. Scott Anderson, chief economist at Bank the West, sees it below 4 percent by March. It could tumble as low as 3.6 percent by year-end, according to a forecast at Ameriprise that noted it hasn’t been that low since 1969.
Even so, workers have failed to see a surge in wages. That may change in 2018.
The job market is still working through the pool of labor sitting on the sidelines, out-of-work but not looking and not counted in unemployment statistics. Behravesh says more than 1 million, perhaps 1.5 million, workers still have to reenter the workforce before wages hit an uptrend, likely by the end of 2018.
“It’s coming. It’s not here yet, but it’s coming,” Behravesh said.
Fuel on a fire
Workers won’t have to wait for raises to see larger paychecks, thanks to the $1.5 trillion tax cuts enacted in Washington.
Tax withholding from paychecks is expected to decline perhaps as early as February and that will mean more take home pay for many.
Businesses are getting even greater tax cuts, with the corporate rate falling from 35 percent to 21 percent. Even H&R Block Inc. sees the tax deal as a boost to its own profits.
Lower taxes should give the economy an extra boost in 2018. Before the law passed, economists at Wells Fargo Securities raised their growth forecasts by 0.3 percentage points. Ameriprise senior economist Russell Price said it would add 0.4 percentage points.
Good, not great. And hopefully not so much that it pushes the economy into overheating. President Donald Trump is now campaigning for a spending increase that targets infrastructure projects and $200 billion of direct federal spending.
That tax cuts and spending increases arrive just as the recovery has hit full stride may cause problems. Inflation could begin to rise after remaining persistently low.
“Inflation will be the big story in 2018,” Michelle Meyer, head of U.S. Economics wrote to clients of Bank of America Merrill Lynch.
She argues that technology, globalization and other structural forces have kept inflation in check. Rising wages could offset that and push prices up generally, though Meyer’s forecast is for only 1.8 percent inflation in 2018.
Wages could upend those forecasts if they rise as fast as Jack Albin, chief investment strategist at BMO Wealth Management, expects. He sees pay in the first half of 2018 being 3 percent higher than a year earlier.
Albin notes that a surge in inflation “would signal the end of the business cycle and represent a key financial catalyst that would prompt a rollback in stocks.”
Inflation’s mild pace so far has kept the Federal Reserve content to raise interest rates at a plodding pace even as the recovery has strengthened. The Fed’s own forecasts suggest three rate hikes in 2018.
Forecasters say four increases would be a problem.
After years of fighting slow growth, weak job markets and threats of deflationary spirals, the Federal Reserve may need to confront financial excesses.
Warnings of excesses have been the battle cry of those who have opposed the Fed’s persistently low interest rates and its $3 trillion bond buying program called quantitative easing, or QE. QE advocates said it was necessary to bolster the sluggish recovery.
In December, the Fed took its first small step to unwind its massive bond holdings, a task dubbed by one of its policymakers as an ongoing experiment in monetary policy.
In 2018, the job falls to untested Fed leaders. The Fed will have a new chair in February, as Janet Yellen gives way to Jay Powell, and needs a new vice chairman.
The New Year arrives with some noteworthy candidates for financial excess.
None looks more likely than the cryptocurrency called bitcoin. Bitcoin is an electronic currency whose validity rests on a technology called blockchain and lacks any government backing, which is a selling point for many of its advocates.
Increasingly, vendors are accepting bitcoin as payment though they typically convert it to dollars. A year ago, one bitcoin brought its owner less than $1,000. Recently, bitcoin went for about $15,900, and topped $19,000 just a couple of weeks ago.
Bidders have become so rabid for anything bitcoin that one small publicly traded company called Long Island Iced Tea changed its name to Long Blockchain Corp. and saw its stock soar, as have others, according to Bloomberg.
Unicorns offer another sign of financial excess. These are mostly new-economy companies that private investors have valued at more than $1 billion. The Crunchbase Unicorn Leaderboards counts 269 unicorns so far.
From fear to greed
Wall Street itself could benefit from a breather in some analysts’ estimations.
Heading into the last trading days of the year, stock prices have failed to retreat as much as 3 percent at a stretch in 2017, as measured by the Standard & Poor’s 500 index. Assured of a gain for the year, the S&P marks its ninth plus year in a row.
The Dow Jones industrial average posted more records than there were weeks in the year with the S&P and Nasdaq stringing records as well.
In 2017, the Dow gained 25.1 percent, the S&P 500 climbed 19.4 percent and the Nasdaq 28.2 percent. Somewhat left behind was the small-stock Russell 2000, up 13.1 percent.
Investors have had reason to be bullish. Corporate profits jumped in 2017 and are expected to jump again in 2018.
The concern is that investor sentiment may be getting ahead of reality. Bank of America Merrill Lynch strategist Savita Subramanian put it this way:
“The year 2017 represented a shift in investor sentiment from skepticism to optimism, and 2018 could represent the move toward euphoria, which typically heralds the end of a bull market.”
That wasn’t a bearish forecast. She said the market still has room to run “before reaching euphoria,” but the balance of rewards and risks in stocks is less favorable than a year ago.
Stocks are more likely to “test investor resolve” in 2018, according to the new outlook from the prescient team at Robert W. Baird. The economy has hit a new pace, they say, but this remains the same old stock market. In their forecast, stocks are most likely to end 2018 where they started and follow a volatile path along the way.
“Investors would be well-advised to see this passing year as a gift to be appreciated and not likely to be repeated any time soon,” their 2018 outlook cautioned.
What could trigger a setback in stocks, even without disrupting the economy?
Leading candidates include difficulties in talks to rewrite the North American Free Trade Agreement, though economists see too much at stake for the United States to walk away from free trade with Canada and Mexico.
A surprise from the Fed is another candidate for sudden stock market sobriety. If the Fed raises short-term interest rates faster than long-term rates rise, it could slow the economy. If short rates become higher than long-term rates, worries about a recession will emerge.
Recessions are notably absent from most current predictions. But even the optimists refuse to exclude the possibility completely.
“You don’t have a lot of visibility on recessions,” said Wells Fargo chief economist John Silvia. “They come up pretty quickly.”