Key Perspectives: Economic Outlook
A gap has developed between public sentiment and actual economic results. Those who expect better economic numbers to close that gap note that sentiment often leads economic results. Others think that failure to achieve major policy changes in Washington will sober the optimism that soared in the wake of the U.S. election.
In part, however, the elevated optimism also reflects a major global recovery that occurred over the last year. That recovery allowed the manufacturing sectors of most economies to pull back from what seemed destined to be a significant decline
A significant part of that recovery traces to the rebounding fortunes of the energy sector. The partial recovery of oil prices lifted manufacturing as energy companies again invested in exploration, development and production. While we think that prices are sustainable at this level of output, we see little chance that oil output can move significantly higher without new supply again putting pressure on prices. Current oil production will continue to contribute, but the growth from expanding production may have run its course.
Strong government spending programs, which supplemented the monetary stimulus programs already in place, also contributed to the global growth acceleration. China, in particular, implemented a strong spending program in late 2015 and early 2016 that seems to have generated significant economic growth in many of the world's economies.
Since China's program has ended, potential growth both in China and in other parts of the world should be reduced. And while most stimulus programs are being maintained, many countries have suggested they may begin to taper their programs before long. Accordingly, while global growth should remain solid, the stimulus programs that helped economic acceleration have ended or may wind down before long.
The U.S. economic cycle is also fighting a battle with age. With the economy apparently close to full employment, firms report that they are having increased difficulty hiring enough help. Wage rates are also beginning to rise and will likely accelerate as labor markets tighten further. Full employment in the economy raises the risk that labor shortages will both limit overall growth and become an increased source of inflationary pressure.
Nothing in the economic cycle to this point suggests a recession is likely any time soon. Still, the global excess of manufacturing capacity that has limited growth over this cycle remains a headwind and the aging economic cycle could limit growth and profitability. Nonetheless, growth appears to be improving in many overseas economies and earnings growth has improved significantly. Economic growth may remain slower than the optimists hope, but should be strong enough to fuel a continuing equity rally.
U.S. consumer spending
Consumer spending in the first quarter GDP report was extremely disappointing. Warm winter weather allowed consumers to avoid some utility costs, and a delay in tax refunds may have delayed some spending.
The shortfall also may have reflected a recovery from last year's spending splurge. In 2016 spending rose much faster than incomes. When that happens, slower spending often follows. With income growth still solid, however, spending should improve in the coming months.
Additionally, tightening labor markets often lead to rising wages, which should give consumers more money to spend. Improving income levels and strong consumer sentiment surveys suggest that consumer spending should contribute more to growth in the coming months.
U.S. business activity
Capital spending was a major bright spot in the first quarter GDP estimate. Some think that signals we have reached the stage of the cycle where investment will drive faster GDP growth. Notably, however, much of that spending came from surging energy investment as energy prices rebounded. Major new energy investment seems less likely if oil prices stabilize. Excess capacity in other industries also limits the attractiveness of new investment in other areas. Those conditions do not argue for significant amounts of ongoing investment spending.
Still, improved business optimism should lead to some additional growth. Admittedly, if politics derails significant tax or spending changes, business optimism may erode as well. The executive branch, however, tends to have more control over regulatory change and many businesses have said deregulation would be a major positive for them.
Growth has picked up in many of the overseas economies, making international growth more competitive with U.S. growth. That not only improves the potential for overseas returns, but takes pressure off the dollar, which improves investment returns for domestic investors.
Although the U.K. has not paid a heavy cost for Brexit so far, the negotiations are just getting under way. Currency weakness has helped spur their economy, but inflation measures have also risen.
The French seem less likely to leave the Eurozone. Nonetheless, high levels of youth unemployment and other frustrations continue to make the Eurozone vulnerable to other defections as the Brexit negotiations get underway. Strong Purchasing Manager Index numbers for that area suggest that improved economic results may help ease the discontent.
Japan's economy continues to show progress, in part because their authorities avoided blunting facilitative monetary policy with tax increases. Japanese exports rose by 12.0% in March, the highest level since January 2015, while rising retail sales suggest improvement in the domestic economy as well.
Australia showed signs of softening, both on the consumer and industrial sides of the economy. Consistent with the contraction in Australia's manufacturing sector, retail sales growth over the last year reached its lowest level since July of 2013.
As China reported 6.9% GDP growth, the 7.6% year over year (y/y) gain in industrial output reached the highest level since December of 2014 while retail sales outdistanced both with a 10.9% y/y gain. Unfortunately, much of that growth may be due to the government spending that has ended. Recent signs of weakness have caused China to back away from tightening, but suggest that economic growth will slow in the coming months.
About Bruce McCain
Bruce McCain is the Chief Investment Strategist for Key Private Bank, where he monitors the economy and the financial markets and serves as part of the team that formulates investment strategies for clients. He supplies frequent insights to media throughout the region and around the country. His comments and interviews have been featured in such publications as The New York Times, The Wall Street Journal, Investor's Business Daily, and Business Week, as well as on television outlets such as CNBC and Bloomberg TV. He is also a regular source for wire services such as the Associated Press and Reuters and is a Contributor on Forbes.com. Bruce joined a predecessor of Key in 1987, after spending six years on the business faculty of the University of Iowa's Henry B. Tippie College of Business. Bruce earned a PhD in Business Administration from the University of California at Berkeley, and undergraduate degrees in Psychology and Accounting from Boise State University.