Our Macro View

THE MACRO VIEW: The Caterpillar Economy

As 2018 ushers in the third-longest expansion is US history (dating back to 1854), we expect solidly paced moderate growth of about 2.7%. Whereas growth in the mid-2.0% area was once considered subpar, we believe it is a reasonable expectation for the US economy going forward. Reduced labor force participation, aging demographics, and low productivity cannot structurally support the 3.0%-plus annual growth rates that prevailed in past decades.

As caterpillar-like growth continues, our “recession dashboard,” composed of the following four indicators, shows no apparent signs of recession in the upcoming year:

  • The Leading Economic Index is still advancing

  • The stock market continues to post gains

  • The yield curve remains positively sloped

  • Consumer confidence is near a record high

Global growth prospects appear equally bright. Of 154 countries followed by the International Monetary Fund, only a half-dozen are forecasted to be in recession during 2018—a rare occurrence of synchronicity. According to the IMF, global growth for 2018 should average a respectable 3.7%.

 

A Supportive Environment for Risk Assets

The moderately expanding economy, globally accommodative monetary policy, low interest rates, low inflation, and sound corporate balance sheets have provided a supportive foundation for risk assets during the past year, an environment we expect to continue in 2018. US corporations enjoyed strong revenue and earnings growth, and investor demand for risk has been robust. Positive earnings and sentiment have been reflected in climbing asset prices. Any price weaknesses during the year proved temporary as investors took advantage of perceived buying opportunities. Valuations are rich, but higher prices can be justified to a degree in the current environment. Volatility, on the other hand, seems artificially low and we expect it to increase in 2018.

 

Caveats

We are optimistic about the new year, but all forecasts have risks. Here is our list of concerns that we believe bear watching:

  • Slowing loan growth is a bit of a puzzle given the expanding economy. Credit expansion is fundamental to ongoing economic growth. We suspect legislative uncertainty surrounding the deductibility of corporate interest has been a contributing factor.

  • US consumer spending, the engine of economic growth, recently outpaced real wage growth, indicating that consumers are spending more than they make. Such spending is unlikely to be sustainable.

  • Companies are spending, too; US corporate debt levels have reached levels last seen prior to the past two recessions.

  • Potentially slower economic growth in China would negatively impact emerging market growth.

  • Although we believe the chance of war with North Korea is slim, we would be remiss not to mention it.

  • Finally, there is policy risk—both fiscal and monetary—which we believe is the largest risk facing the US economy. Changes in the FOMC, tax reform, and regulation provide ample opportunity for things to go awry.

 

Sustainable Growth for Now

The benefit of the slow-growing caterpillar economy is that it can continue in this manner for a protracted period. Our 2018 forecast looks much like our 2017 forecast: moderate growth, no recession, benign inflation, global expansion, and a favorable environment for risk assets.

 

The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance.