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Forecast 2019, Sunny Conditions Continue: But Economists Ask, “How Long Will It Last?”
Economic Forecast 2019: The coming year promises a robust business operating environment, with a growing economy supporting healthier profits. The sunny jobs picture should brighten still further and fatten consumers’ wallets. At the same time, economists are starting to see early signs of an eventual correction.

By Phillip M. Perry
Date Posted: 12/3/2018

Businesses should enjoy brisk economic tail winds in 2019. Corp                rate profits will continue to rise at a nice pace, and the improving job market will inspire consumers to spend freely. It should all translate into a healthy operating environment for the coming 12 months, although economists are starting to see early signs of an eventual slowdown.

“The business cycle has entered its boom phase,” said Sophia Koropeckyj, managing director of industry economics at Moody’s Analytics, a U.S. research firm (www.economy.com). The nation’s total revenues from goods and services, or the Gross National Product (GNP), the most commonly accepted measure of economic growth, is expected to grow at a 2.7% clip in 2019.

Despite the generally sunny outlook, the GNP forecast represents a modest deceleration from the 3.0% increase anticipated when 2018 numbers are finally tallied. Why? “There are several reasons for slower growth in 2019,” commented, Scott Hoyt, senior director of consumer economics for Moody’s Analytics. “The largest is that deficit-financed tax cuts at the start of 2018 lifted growth. No such support, in terms of an additional increase in after-tax income, is expected in 2019. In addition, job growth will be slower because of there being fewer available workers.” Finally, Hoyt notes that interest rates will likely be higher, a factor that can have a softening effect on business investments.

 

Profits Grow

Going into 2019, business owners possess a lot of optimism. That’s fueled by healthy corporate profits, which are expected to rise by 3.7% in 2019, according to Moody’s. “We expect corporate profits to benefit from the tax reform mainly through the lower top tax rate and the new equipment accelerated expensing provision,” explained Koropeckyj. “Another positive to corporate profits is the rollback of Dodd-Frank Act provisions, which had increased costs for businesses.”

The anticipated level of business growth actually represents a deceleration from the 6.9% increase expected when 2018 numbers are tallied, a moderation largely due to an anticipated rise in labor costs and higher interest rates.

Reports from the field corroborate Moody’s readings. “Our member companies are reporting significant upticks in business growth, and most are anticipating a healthy 2019,” stated Tom Palisin, executive director of The Manufacturers’ Association, a regional employers’ group with more than 370-member companies (www.mascpa.org). “There is so much demand they can’t keep up. Lead time has extended appreciably, from a couple of months a few years ago to three to six months today.”

Business optimism rests atop a firm base of consumer confidence, always an important driver for the economy. “Consumers seem to be euphoric right now,” suggested Hoyt. “The fiscal stimulus in the form of tax cuts, as well as the tight job market, mean there are very few negatives when it comes to consumer fundamentals. The fact that consumer confidence is near historic highs makes sense given the current conditions of low unemployment and the gradual increase in wages—even though wage growth is still not high.”

 

Wages Rise

There’s no doubt that consumer confidence is rising in response to a happier jobs picture, one that should only brighten in the months ahead. Moody’s expects unemployment to drop to 3.4% by the end of 2019, down from the 3.7% recorded at the end of 2018. (Moody’s Analytics first declared that the economy had reached the state of what is often called “full employment” with its 4.1% showing in 2017).

 “The fundamentals of the labor market look good at least into the mid-year of 2019 and probably longer,” said Hoyt. “The nation is adding jobs faster than the growth in the wage-earning generation, so we expect a further tightening of the labor market in 2019.”

And it seems that healthy job growth is finally affecting wages. Average hourly earnings are expected to grow by 3.2% in 2019, up from the 2.8% of 2018 and the 2.6% of 2017, according to Moody’s.

 “The recent rise in wages is very good for the economy,” said John Manzella, a consultant on economics and global business (www.JohnManzella.com). “The more disposable money consumers have, the more they spend, and consumer spending represents 70% of the nation’s economy.”

You’ll get no argument about the importance of steady work from consumers. Indeed, the flurry of paychecks seems to be a more important consideration for people than any negative economic news. “Consumers do not seem to be worried about the effects of a possible trade war, or gridlock in Washington, or the rise in gasoline prices that has taken place over the past year,” added Hoyt.

 

Housing Rebounds

Yet another powerful driver of business and consumer sentiment, the housing market should deliver good news in 2019. Moody’s believes housing starts will rise by 19.4% in 2019, a substantial increase over the 7.0% expected to be clocked when 2018 is finally tallied. Median home prices should rise by 2.7%, slower than the 4.8% of 2018.

The challenge for home builders is finding enough workers. “Residential construction as a whole remains bedeviled by a shortage of capacity,” explained Koropeckyj. “The unemployment rate for experienced construction workers is at a record low of less than 5%, suggesting that construction labor for the U.S. as a whole is critically short.” Shortages in workers with certain skills, such as electricians and steel-erection specialists, are particularly acute.

Indeed, the labor shortage contributed to a leveling out of construction starts for new and existing home sales and multifamily housing through the first half of 2018. “The construction industry has been operating at full capacity and is still struggling to reduce its backlog of projects,” commented Koropeckyj. The coming 12 months should experience a rebound as new multifamily building ebbs, releasing workers for the less labor-intensive single-family category.

A healthy retailing sector is an important factor in a growing economy, and here again the outlook is good. “The coming 12 months should be a good year for retailers,” forecasted Hoyt. Core retail sales are expected to grow 4.7% in 2019, a bit slower than the 5.0% growth expected when 2018 numbers are finally tallied, but better than the 4.1% increase clocked in 2017. (Core retail sales exclude the volatile auto and gasoline segments.)

 

Clouds Loom

Troubles, as always, loom on the horizon. The major near-term concern for businesses is the rise of protectionist trade policies. “The growing uncertainty caused by the trade war is throwing a monkey wrench into a finely tuned system and creating volatility,” warned Manzella. A common cost-cutting measure—sourcing products from countries not subject to import tariffs—is no panacea.

 “Unless such companies can buy in large quantities, they often find that price points are higher,” said Manzella. “As a result, they end up raising their prices to unfavorable levels.”

An equally troubling issue is the effect tariffs have on confidence, added Manzella. “When companies are faced with an uncertain future they typically hold onto their cash, invest less and spend less, and that puts downward pressure on economic growth,” agreed Koropeckyj. 

 “Escalating trade tensions between the U.S. and China could dampen investment more than expected,” she worried. “Company profits may be squeezed by the higher costs of imports. Not only could affected companies be hurt more than expected, but an erosion in business confidence due to heightened uncertainty would weigh on spending decisions.”

A related issue involves Chinese tariffs placed on US imports, boosting costs to Chinese consumers and industries, said Manzella. “Chinese importers are reacting by looking for alternative sources from other countries,” he added. “A major fear is that the Chinese may just stick with those alternative sources even after the trade war is minimized.”

Retailers largely share the concerns of general businesses. “For retailers, tariffs are the monkey wrench that everyone is trying to figure out how to deal with,” admitted Bob Phibbs, a retail consultant based in Coxsackie, NY (retaildoc.com). “They will affect margins and ultimately consumers will pay for them.”

Here are some other potential problems peeking over the horizon, for businesses of all stripes:

Labor shortage. “The labor shortage and skills deficit are major issues for businesses,” suggested Manzella. “If you can’t find the employees you need, you can’t grow your business. And if you have to go where the skills are, that might mean moving overseas.”

Palisin agreed, “In our survey, about 70% of manufacturers plan to increase employment next year, but over 90% have had difficulty hiring enough skilled trades. They are especially concerned about what’s called ‘the silver tsunami,’ in which baby boomers are leaving the workforce, taking their skills and knowledge with them. At the same time not as many young people are going into skilled trades.”

In response to the talent shortage, manufacturers are increasing work hours for their current employees, introducing more automation, and running apprenticeship training programs to build workforce pipelines within their companies. “All this will help, but it won’t solve the problem,” explained Palisin. “That’s why many companies are being proactive in promoting manufacturing careers in their local school districts.”

Wage hikes. It’s the negative result of low unemployment: Higher labor costs. “With the economy chugging along as it is and unemployment lower, employers may need to raise wages to attract enough people,” said Hoyt. That can crimp profits.

Rising interest rates. Higher costs of money pose a challenge for everyone, especially if the Federal Reserve raises rate too quickly. “Rising interest rates may not cause much impact in the short term,” predicted Palisin. “But later in 2019, the higher cost of money may start to constrict the availability of capital.”

A “hard Brexit.” If the United Kingdom fails to land a favorable deal with the European Union, an unmoderated departure can cause problems to the world economy. “We expect a Brexit deal to be reached at the last minute,” said Hoyt. “If it is not, it would be a negative for the global economy and U.S. consumers as supply chains and movement of workers would be disrupted.”

 

Business Cycle Ages

To look a bit further down the track, there are signs that the fast-moving economic carriage may be nearing the top of the roller coaster. “The nation is experiencing robust economic growth, tightening labor and product markets, intensifying wage and price pressures, monetary tightening, and higher interest rates,” said Koropeckyj. “These characterize a business cycle nearing its end, just prior to a recession.”

When might that event occur? “We prefer not to forecast recessions, because they are often caused by shocks that cannot be predicted,” reminded Koropeckyj. “However, our forecast for 2020 includes a set of conditions that are consistent with a recession. While we do not expect the textbook definition—two quarters of GDP decline—to occur, real GDP growth is expected to slow to a crawl.”

Other relevant predictions include a too-rapid increase in unemployment, the cessation of job growth, flat industrial production and a deceleration of personal income growth.

For businesses of all stripes, the prudent course seems to involve capitalizing on the current good times while setting up Plan B for the inevitable correction. “Businesses are optimistic about 2019, but we are all aware that recessions are cyclical,” said Manzella. “And there is no doubt that the next recession is on its way. The only question is when.”

 

Watch These Trends Early in 2019

How will 2019 turn out for businesses? Will commercial activity begin to slow in the months ahead? When will the next recession begin?

To help answer these questions, economists suggest watching a number of important indicators in the early months of 2019.

 “I would keep a close eye on the political environment,” says Scott Hoyt, Senior Director of Consumer Economics for Moody’s Analytics, a research firm based in West Chester, Pa. (economy.com). “What is going on with tariffs, and is there a risk of a trade war? Beyond that, I would watch for indications about the anticipated pace of interest rate hikes from the Federal Reserve. At some point those will start to bite and put a damper on growth. That will probably be an issue for later in 2019, but the faster rates go up the sooner the economy might be affected.”

Wage growth will also be an important leading indicator, according to Sophia Koropeckyj, managing director of industry economics at Moody’s Analytics, “Despite nearly a decade-long streak of job gains, wage growth has been slower that would be expected given the tightness of the labor market. Over the past few quarters wage growth has finally reached near 3% and with the economy close to or at full employment, wage gains could begin rising faster than expected. This could translate into higher than expected inflation if employers pass through higher wages.”     

Similarly, said Koropeckyj, price growth could be faster than expected if trade actions cause companies to pass on their higher costs in the form of higher prices.

 “Given the tight labor market, employment growth is another important indicator,” says Koropeckyj. “The economy has been adding jobs at a remarkably steady pace around 200,000 per month since 2012. The labor market may run out of steam in 2019, especially if the stimulus from higher government spending and tax cuts begins to fade.”

Finally, keep an eye out for excessive business risk-taking that can backfire on the larger economy. “Businesses eventually make investments that do not pay off, developers overbuild, and creditors extend too much credit,” commented Koropeckyj. “Most notable today is heightened lending to already-highly indebted nonfinancial businesses. This so-called leveraged lending has taken off recently, creating concern that these companies will have difficulty navigating the next recession and that resulting bankruptcies and losses will stress the economy and financial system.

 “More broadly, by requiring banks to hold more capital and be more liquid, risk-taking is shifting to the less regulated and more opaque part of the financial system known as the shadow system, an array of nonbank institutions, including asset managers, derivative exchanges, payment processors, insurance companies and pension funds.”








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Economic Forecast 2019