A slowing economy. Costly tariffs. Brexit angst. A presidential election. A shaky stock market. Rising labor costs. A looming recession. And happy consumers.
Those are the ingredients of a mind-bending cocktail of economic uncertainty now eroding business confidence and capital investment. Despite a state of full employment, robust consumer spending, low interest rates and a strong housing market, forecasters are predicting a challenging operating environment in the year ahead.
Slowing Growth
“We look for the economy to grow below its potential in 2020,” said Sophia Koropeckyj, managing director of industry economics at Moody’s Analytics, a research firm based in West Chester, Pennsylvania. (economy.com). “Corporate profit margins have been compressing noticeably as growth in labor costs has outpaced revenue growth. Shrinking margins are often associated with late-cycle expansions and often cause businesses to be more cautious in hiring and investment.”
Moody’s expects the nation’s Gross National Product (GNP) to slow to 1.7% in 2020, down from a more normal 2.3% anticipated when 2019 numbers are finally tallied. The 2019 performance is a decline from the 2.9% growth clocked the previous year.
Strong Hiring Despite Overall Economic Slowdown
Reports from the field reinforce Moody’s calculations. “In the last part of 2019, concern about tariffs resulted in a slowdown in the automotive and agricultural sectors, and a lower level of orders caused some companies to reduce their size,” commented Tom Palisin, executive director of The Manufacturers’ Association, a York, Pennsylvania-based regional employers’ group with more than 370 member companies (mascpa.org). With its diverse membership in food processing, defense, fabrication, and machinery building, Palisin’s group can be seen as something of a proxy for American industry.
Despite the slowdown, Palisin reassured, most of his members continue to enjoy good profits and to hire when they can find the right workers. That success, though, is tempered by a year-long gradual decline in the lead time required to fulfill orders—a common indication of decelerating revenues throughout the supply chain.
“Manufacturers experienced significant lead time in the first quarter of 2019 as a result of high demand and capital spending,” explained Palisin. “Lead time shortened as the year progressed, to what is now an average level. We expect lead times to remain average in 2020, due to headwinds that may moderate economic growth.”
Happy Consumers
The current economic picture is not lacking bright spots. The most pronounced is a consumer who seems largely contented with the way things are working out, thanks to healthy employment levels that are filling pockets with spending money. That’s important, because consumer spending is a powerful driver of business activity, representing some 70% of the nation’s economy.
The unemployment rate was running at an enviable 3.7% toward the end of 2019, well below what many economists label as “full employment.” Employers have been consistent in their hunt for workers to fill a growing number of positions. “Monthly job growth has been more than enough to keep up with the growth in the working age population,” said Koropeckyj.
Looking ahead to 2020, economists expect recession fears to have a dampening effect on the labor market. “Unemployment is expected to edge slightly higher to 3.9% by the end of 2020, due largely to a deceleration of job growth,” predicted Koropeckyj. “We expect job growth to steadily decelerate and cease altogether in the second half of the year.”
For the time being at least, happy shoppers are good news for retailing, an important driver of the national economy. Moody’s expects core retail sales to increase by 4.0% when 2019 numbers are finally tallied, up from 3.4% of the previous year. (Core retail sales exclude the volatile auto and gasoline segments.)
As for 2020, Moody’s expects retail sales to increase by only 2.3%. “A deceleration of job growth means fewer new people will enter the ranks of active shoppers,” said Scott Hoyt, senior director of consumer economics for Moody’s Analytics. “And that will exert some downward pressure on retail sales growth that may more than offset the positive effect of the higher wages (and thus the greater disposable income) characteristic of a tightening labor market.”
Housing Rebound Predicted in 2020
Confident consumers are maintaining a steady drumbeat of interest in housing, another critical driver of the economy. Moody’s expects 2020 to be the first year of a strong residential construction recovery led by single-family homes. Housing starts are projected to grow 7.0% in 2020. This comes off a rocky 2019 in which starts were expected to drop by 0.7% when the year’s numbers are finally tallied.
Why the dismal 2019 experience? “There have been a number of obstacles to stronger residential construction,” explained Koropeckyj. “The first is a shortage of specialized workers. The second is the prevalence of strict residential zoning regulations, especially in dense urban areas. The third is a shortage of residentially-zoned land within commuting distance of business areas in some metro areas in the Mountain West and Inland South.”
Older Millennials now reaching prime home-buying age are expected to drive the 2020 housing recovery. They will be entering the market at a time when the housing inventory-to-sales ratio is at record lows. The fact that zoning is generally less restrictive for single-family as opposed to multifamily construction translates into a much stronger single-family construction forecast. Relatively low mortgage rates will also help, though these are expected to start rising in 2021.
The housing rebound will be tempered to some degree by declining affordability, according to Moody’s. The median price for existing single-family homes is expected to rise 4.1% in 2019 and 2.9% in 2020, compared with 4.7% growth in 2018. The deceleration of price growth in 2020 is due largely to the increase in housing starts bringing more units to the marketplace, as well as to price resistance from buyers. “Even though home prices will decelerate they will still increase and ownership will become even more out of reach for many households than it is today,” said Koropeckyj.
Banks, for their part, seem to be filling their critical role in a robust housing market. “Mortgage lending has been continuing unabated and largely concentrated among borrowers with high credit scores,” commented Koropeckyj. “We expect this pattern to hold in the future.”
Interest rates are expected to continue to play their vital role in supporting mortgages. “In 2019 interest rates turned lower rather than higher, which was a surprise,” said Hoyt. “The reason was the unanticipated trade war which was clearly a negative and reduced economic prospects significantly relative to expectations.”
Tight Labor to Remain a Problem for Employers
If robust employment is keeping the consumer happy and the housing market bustling, employers are tearing their hair out.
“Because of the tight labor situation our companies have not been able to add as many workers as they would like,” stated Palisin. “As a result, it can be difficult for many of them to take on new business. We expect that to remain a problem in 2020.”
Industry is also seeing more job shifting, in which people leave their current positions for opportunities elsewhere. “Employers are now looking at whether they need to adjust their compensation policies to retain the talent they have developed,” added Palisin. “So far, we have seen only a gradual increase in the cost of labor, but we expect more accelerated wage growth in 2020.”
A tight labor market is expected to be with us awhile. “The workforce will be put under continuing pressure in the future,” said Palisin. “Over the next 15 years for the first time in the U.S. there will be more people of retirement age than under the age of 18. And a contraction in immigration is also putting pressure on the workforce. Companies will have to look for other ways to grow without hiring workers who might not be available.”
If you can’t get enough people, let robots do the work. That’s the mantra for the employer of the future. “Rather than invest in recruiting and training people for labor intensive jobs, our members have been investing in automation and capital equipment,” commented Palisin. “We expect this trend to continue in 2020.”
Not all employers, though, can foot the bill. “While larger companies can automate internally, small and mid-sized ones need to call in external consulting resources,” said Palisin. “That can be challenging because many smaller businesses do not have the financial resources to do so.”
Indeed, manufacturers around the nation seem to be shy of investing too much in capital improvements of any kind. “Manufacturers are nervous, despite their success in reaching their earnings estimates,” warned Bill Conerly, principal of his own consulting firm in Lake Oswego, Oregon (conerlyconsulting.com). “This is showing up in capital spending numbers, which were big in 2018 coming out of tax reform but which are not so big now.”
Even forays into automation are on hold. “Labor costs are going up, and good workers are hard to find,” said Conerly. “Interest rates are low and companies are flush with cash. You would think that investment in labor saving technology would be going great guns, but it’s not. Why? Uncertainty. Businesses wonder if economic conditions in the next few years will justify more capacity or even more efficiency.”
The numbers from Moody’s support Conerly’s observations. “We expect real nonresidential fixed investment to grow by 3.2% annualized in 2019 and 2.8% in 2020,” said Koropeckyj. “That’s well below the 5.4% average over the last two years.”
Trade War Disrupts Supply Chains
A scarcity of skilled workers is just one of the many headwinds restraining American businesses. Another is supply chain confusion—a direct result of the China trade wars. “Uncertainty about international trade rules can throw havoc into the production system,” advised Conerly. And that havoc is only intensified by the complexity of modern supply chains. “Parts for finished goods are coming from multiple countries. The more complex the chain the less resilient it is, and the more opportunity for things to turn bad.”
Adjusting to supply chain disruption is easier said than done. “Some of our companies are trying to move their supply chains out of China, but that means abandoning long held relationships,” explained Palisin. “Validating new suppliers is costly and time consuming. Smaller and mid-sized companies, in particular, do not have the resources to quickly find new sources of materials.”
Lending urgency to the supply chain disruption is the knowledge that long-established relationships, once lost, can be difficult to restore once trade tensions ease. And on the flip side of the trade coin, domestic makers fear losing their overseas markets permanently to rivals from other countries.
In a reflection of these supply chain disruptions and of the slowing global and domestic economy, Moody’s expects corporate profit to increase by only 1.9% when figures for 2019 are finally tallied. This less than stellar increase only adds to the uncertainty that is keeping companies from investing in the very capital projects that can help drive economic growth.
Moody’s expects better results in 2020, when corporate profit growth should increase by some 4.9%. “Contributing to the rebound is a weaker U.S. dollar, which will improve the competitive positions of U.S. goods, so that profits from abroad will increase,” predicted Koropeckyj. She adds that while the 2020 figure looks comparatively robust, it remains weaker than the average 5.2% growth between 2009 and 2018.”
The Road Ahead
Despite the uncertainty that characterizes many areas of the economy, a healthy labor market and high consumer confidence have done a good job propping up a decelerating business environment. Will they continue to do so? And when will the inevitable recession arrive?
That last question is particularly important, as two-thirds of the nation’s chief financial officers expect the United States to tip into an economic downturn by the third quarter of 2020, according to a Duke University/CFO Global Business Outlook survey. In the early months of the new year, economists suggest monitoring financial news for indicators of a recession, often defined as two consecutive quarters of negative economic growth. Increasing stock volatility is one such indicator, as is an inversion in the Treasury yield curve when short-term rates are higher than long-term ones.
But perhaps the most important indicator of pending trouble is a downturn in the employment picture. “The job market is key,” suggested Koropeckyj. “If businesses begin to lay off workers, that will be fodder for recession. Watch for changes in monthly employment growth and in weekly claims for unemployment insurance benefits.”
Rising unemployment, said Koropeckyj, will result in a decline in the very consumer spending that has been the driving gear of a healthy economic machine. He added, “Once unemployment starts rising, we are either already in a recession or will be in one very soon.”
