The longest expansion on record keeps trucking along. Can we make it through 2020 without any major slowdown? Can we get to the promised strong 3% growth pace? And what about trade wars? We always enter a new year with questions about the economy, and this year is no exception.
The current expansion began in June 2009 and is in its 127th month. The previous record of 120 months occurred between March 1991 and March 2001. Yes, some quarters were negative, but they were few and far between. And usually, those declines were due to special factors, such as the collapse in oil prices that cratered the energy sector.
And that raises the question: What could cause the next recession?
First, keep in mind that expansions don’t just die of old age. There is no reason we cannot keep going for years. It usually requires a bubble bursting or a policy mistake to bring on a recession.
The last two recessions were created when the dot-com and housing bubbles burst. Irrational exuberance in the equity and housing markets drove up prices to unsupportable levels and, ultimately, reality set in.
Are we facing any bubbles? Maybe, but that is not clear.
Consider the labor market. The number of job openings exceeds the number of people unemployed. That should mean demand exceeds supply and wage gains should be accelerating.
But although that had been the case from 2014 to 2018, last year, compensation increases slowed. Firms are finding ways, other than raising salaries, to retain and attract workers. That is limiting the threat of a wage bubble forming that could cause inflation to accelerate and ultimately a recession.
What about the equity markets? There are also concerns there but the data are a bit misleading. The markets did exceptionally well in 2019 as the major indices rose by 20% to 30%, on a December over December comparison. These outsized gains are disturbing, as they are not supported by last year’s moderate growth and modest increases in earnings.
However, much of the excessive rise was due to a temporary sharp correction during the final part of 2018. That distorted the comparison. Looking at it on a quarterly basis, the gains were about half as great. Those are still large increases but not nearly as worrisome.
As for housing, price gains faded and sales and construction rose moderately last year, so we cannot say there is a housing bubble.
In other words, there are no immediate threats of a recession being created by bubbles bursting, though the issues in the labor and equity markets have to be watched.
What about policy mistakes? That is different. Typically, an extended period of growth would cause some markets to tighten and inflation to accelerate. The Fed would step in and raise rates, usually too far, too fast. A recession would follow.
Now, rates have declined and are extremely low, so the threat of a Fed-tightening mistake is limited.
The one big policy danger remains the trade war. Although there is a truce right now, significant pressures remain between not only the U.S. and China but also the U.S. and Europe. Additional tariffs could trigger a further slowdown in U.S. and global economies that might send us into recession.
So, barring a policy mistake on tariffs, there is little reason to think the economy will falter this year.
Can it accelerate from what appears to be a return to the 2% pace seen in the 2010s? There seems to be little reason to expect that.
Consumers are the driving force in the economy, and as mentioned, income gains are fading, not accelerating. The best we can expect is continued moderate consumption increases. Meanwhile, labor shortages are limiting the ability of businesses to expand.
Business investment has been modest, in no small part because earnings were largely flat last year. Corporate taxes may have been cut in half, but it is profits and economic fundamentals that drive investment. Given expected moderate consumer spending and forecasts that global growth will not accelerate, it is hard to see how investment will surge.
So, when you look at the sectors that power the economy, the best we can expect this year is the same as last year: about 2.25% growth.
But that is not bad. Given the shortage of workers, the promised 3% growth pace might have put so much pressure on hiring that wages would have soared. Instead, compensation gains are manageable, and as long as they remain that way, inflation will stay under control.