The conventional economic wisdom (as defined by the forecasts of the most respected economists) last year, was that GDP would not be able to hit 4% for any quarter in 2018. When the economy achieved 4.1% in 2018Q2, the conventional wisdom was that it was a blip and that growth rate could not be sustained. But it looks like Q3 will come in around 4% again. Now the conventional wisdom is that economic growth has peaked in this cycle. The economy will start to slope downward in Q4 and continue to ease in 2019, eventually returning to trend growth of somewhat above 2%.
The question I have been asking colleagues and analysts lately is: What happens if these so-called experts are wrong again. What happens if we get two more quarters of 4% growth?
Now, there are several things that support the conventional outlook. The economy is very cyclical and, now that the economy has been allowed to upcycle, we should expect some type of downcycle, maybe even a recession. Unemployment is at a 49-year low, and the unemployment rate usually bottoms out as the economy peaks. So, how low can it go? Also, it makes more sense this time because companies are having trouble finding more workers to produce more stuff. If you can’t sell and produce more stuff, the economy can’t maintain its current growth rate.
Establishing A Baseline
The WSJ survey reflects the “conventional wisdom” view described previously, with the economy back to trend growth, possibly early in 2019. There is a wide gap in the low vs. high forecast numbers in the survey, indicating the next year contains a high degree of uncertainty. However, these outlier forecasts do not seem feasible. It would be difficult for the economy to accelerate going into 2019; likewise, it would be a surprise it the economy cooled that rapidly, unless there were a shock to the system (however, as I am typing this, the stock market is plunging again). The FTR forecast is more optimistic, showing a gradual easing back from the peak, and still growing at a healthy 3.3% rate into the second half of 2019.
A Look At The Forward Looking Indicators
Now that we have a baseline to work from, let’s see what some forward-looking economic indicators are saying.
The Conference Board Leading Economic Index has cooled from the hot numbers of last October through February, but they are still vibrant. However, the Weekly Growth Index from ECRI has cooled considerably from Q1, even briefly touching negative in August.
The ISM index for New Orders and Backlogs indicate manufacturing growth should slow slightly in the coming months. However, the numbers remain historically strong. Growth in Factory Orders flattened during the summer.
Recent numbers on Building Permits show a small y/y gain. The Housing Market Index (HMI) has edged down from the high readings in Q1. The future of the housing market appears to be more of the same, providing neither a boost nor a drag to the economy.
My Discretionary Spending Index (based on key elements of retail sales) shows consumers have plenty of discretionary income, and they are spending it. Wages are finally beginning to increase, and this, combined with low unemployment, bodes well for the consumer segment of the economy.
The NFIB Small Business Optimism Index continues to run hot. Tax reform is really boosting this segment, and the high numbers should lead to more new jobs. The General Activity Index from the Philly Fed is still strong, but lower than it was through the first half of the year. The same is true for the Moody Survey of Business Confidence.
What About the Awful Tariffs?
I have not seen an accurate forecast yet regarding the impact of new U.S. tariffs and retaliatory foreign tariffs. All initial forecasts tend to say the impact will be disastrous and then gradually wither to a forecast of moderate to negligible effect. However, some tariffs are only starting to kick in, so it’s too early to judge. The doomsday forecasts typically assume that if a tariff produces negative consequences, it will be allowed to continue indefinitely. If you view the U.S. tariffs as punitive, this would be the case. If you think the tariffs are strategic in nature, then they will be fluid, and change as circumstances dictate. The tariffs do increase short-term risk for the chance of long-term rewards.
The Truck Equipment Markets
Trucking fleets are ordering Class 8 and commercial trailers in huge, unprecedented numbers. So they expect this economic boom to continue through next year. However, fleets tend to be reactionary and are placing these orders based on the current conditions they are experiencing. As we have seen, the indicators do not predict this trend will continue. The FTR freight forecast is for moderating truckloads in the second half of 2019. Therefore, all the trucks being ordered today will probably not be needed. Expect order cancellations to be pervasive throughout next year.
The data backs up the conventional wisdom that the economy will not maintain its hot pace for much longer. Almost all the indicators point to lower GDP growth in the coming quarters. However, most of the numbers remain relatively strong, which signals only a moderate change.
There is no basis to support a GDP exceeding 4% in the next nine months; however, it doesn’t appear we are headed down to 2% either. There could be a dip to near 2% in 2019Q1, just because recent Q1 readings have been inexplicably low. Therefore, I like our FTR forecast of 3.3-3.9% GDP over the time period.