So-Called Trade War Slows GDP Growth Rate

The Commerce Department lowered its estimate of 2Q 19′ GDP growth rate to 2.0% from 2.1%. The results, which were in line with expectations, portray a U.S. economy that remains is in solid shape (the long-term growth forecast for GDP is 2.0%) but has slowed from what appears to be an unsustainable growth rate above 3% earlier in 2019. In our opinion, the direction of GDP will likely depend on the direction and intensity of the so-called trade wars. Too much slowing in GDP could preempt consumer confidence and push the economy towards the dreaded “R” word.
Gross Domestic Product comprises several elements. Before we talk about recession, let’s take a closer look at the key contributing sectors to GDP. Our colleagues at Argus Research offers these points:

* First, the Consumer. During 2Q, Personal Consumption Expenditures grew at a robust 4.7% pace, rebounding from weak 1.1% growth in 1Q and above the rate of overall growth. The Consumer sector contributed 60.8% of core demand (which we define as Personal Consumption Expenditures, Information Technology and Intellectual Property Spending, Housing, Exports and Government Expenditures). This is in line with the 10-year average, as the consumer continues to drive the U.S. economy. We note the latest consumer line reflected a surge in spending on durable goods, which we do not think is sustainable, particularly if consumer confidence wanes.

* The trade war had a clear impact on capital investment, as the Gross Private Domestic Investment segment declined 6.1% in 2Q. How can this be a surprise? What corporate executive is likely to invest aggressively in new plant and equipment, given the ongoing (and increasing) uncertainty over the direction of free trade in the United States? Drilling deeper into investment into equipment, we note weakness in spending on Structures as well as Information Processing THE ECONOMY and Industrial equipment, which likely are related to trade. Looking ahead, we expect that low interest rates will support cap-ex spending but cannot offset trade war uncertainty. This segment is likely to detract from economic strength as long as trade wars persist.

* Housing has struggled in recent quarters, defying the positive trends in the consumer sector. In 2Q, residential investment declined 2.9%. That’s the eighth decline in the past nine quarters. The housing market has recovered from the collapse of 2008-2009 (somewhat slowly, at least compared to the auto market) and certainly does not appear to be in bubble territory. But the Federal Reserve’s campaign to raise interest rates had a clear and negative impact on the sector in 2018, and a stumble in consumer confidence could stunt any budding recovery.

* Exports slumped in 2Q. Again, this cannot come as a surprise, given the mixed messages from the White House. Exports declined 5.6% in the quarter, including a 6.3% drop in export goods. Meanwhile, spending on imports was steady year over year, which limited some of the negative impact from exports. Looking ahead, we continue to anticipate bumpy trends in export growth in the next few quarters as politicians debate tariffs and trade. President Trump’s latest directive to U.S. companies to “find other customers” besides China could challenge exporters for several quarters at least.

* Government spending is now an economic driver (surprise!). In 2Q, government spending increased at a 4.5% rate after growing 2.9% in 1Q. We may soon see government spending as a key driver of GDP growth. (continued on next page) -2- VIEWPOINT The deficit is obviously not a current worry. The weakness in capital spending and exports, as well as the risk that business and consumer confidence may falter, we feel confident agreeing that a lower forecast for GDP growth through 2020 is probable. We would not be surprised to see quarterly growth (GDP) rates range between 1.5% and 2.4%. Examining 2019, some forecasts call for growth around 2.3%, down from 2.5% in 2018 and 2.7% in 2017. Looking into the coming year, headwinds could further weaken GDP. Some analysts are suggesting an annual rate of only 1.9%.

Risks of Recession
Since the current economic expansion began in the fourth quarter of 2009, the economy has grown for 39 quarters in a row. In the post-World War II era, the U.S. has experienced 10 periods of economic growth, which have averaged 20 quarters, or five years. The longest expansion was 39 quarters; the shortest was five. Recently, expansions have been more durable. The six expansions since 1960 have averaged 27 quarters. But they all end at some point, and it is reasonable to believe that the current expansion is closer to its end than it is to its beginning. Certainly, that’s what the current inverted yield curve is suggesting. Though we note that neither our current estimates nor the Fed’s forecasts call for a recession in the U.S. through 2020, we now think that the likelihood has increased, as the trade war gets longer and deeper. We note that key forward-looking indicators — including jobless claims, building permits and the stock market — are generally positive. But we also point out that Purchasing Managers New Orders readings, the low level of interest rates and global economic weakness pose significant risks to extended domestic growth. Other risks to growth include the potential for geopolitical events; volatile oil prices; a weaker-than-expected recovery in China; additional economic trouble in Europe related to Brexit or government finance problems; a dollar that continues to rise and limits export growth; a steep stumble in the housing market or in consumer confidence; or inflationary conditions, which remained under control in the latest GDP report.

Our Perspective – we remain optimistic as consumer confidence remains solid and the Federal Reserve continues its accommodative stance. Yes, growth forecasts into 2020 call for GDP expansion in the 1.5%-2.5% range, versus the current rate of growth in the 2%-3%. This backdrop would most certainly produce intensified market volatility. However, negotiating with China is ongoing and eventually reaches something of an agreement. We cannot predict the outcome but we are certain that China and America want to achieve results that are tenable and beneficial to all concerned. We see 2020 as a time to focus on quality and sectors which tend to weather economic slowdowns. Talk to one of our advisors about our asset allocation that continues to support equities over bonds. We don’t anticipate change in the current environment.