Source: Bloomberg. Small Business Optimism Index, September 1998 - September 2018
Businesses, however, are having a hard time finding workers. The economy has produced more jobs than job seekers. The quit rate also reached a 17-year high.⁶ Employees now have the confidence to leave their current jobs to find ones with better pay or working conditions.
Trade negotiations and tariffs pose another potential challenge. Tariffs could lower business confidence and slow spending on plants and equipment. But in a U.S. economy of approximately $17 trillion, $250 billion in tariffs aren’t going to have a major impact.
The Tax Foundation estimates that the announced tariffs (including those enacted in mid-September) will reduce Gross Domestic Product by 0.12 percent, cut wages by 0.08 percent and eliminate 94,303 full-time jobs.⁷
With progress on a replacement for NAFTA, focus is shifting to Europe and, later China. Businesses are encouraged by the draft agreement in North America, which is not expected to dramatically disrupt supply chains.
We see tariffs and trade issues as an economic pothole, unlikely to push the economy off its positive track in the near term.
Soft spots: Housing, corporate debt
Even in this bright and shining economy, a few dull spots remain. Residential investment, normally a strong economic driver at this point in the cycle, continues to disappoint.
- Sales of new and existing homes have lagged.
- Mortgage activity has dropped off.
- The housing affordability index from the National Association of Realtors has reached 2004 levels.
Housing is no longer the deal it was in the years after the financial crisis. The debate continues as to why housing is lagging. Low supply, a shift towards renting and aging in place are all headwinds. However, there’s no question that higher home prices and mortgage rates are a burden, particularly for younger buyers with student loan debt and low disposable income.
While the lackluster housing market is a drag on economic growth, we don’t think housing prices are in a bubble. Rather, on the fixed income side we see the housing sector as an opportunity. Consumer credit is generally strong. Foreclosures are way down. With a limited supply of homes, homeowner equity is in good shape. Consumer borrowing is up, but has plateaued at a level within people’s means.
As a result, we’ve been shifting our exposure more toward the consumer-facing sector in our core fixed income strategy, including the structured residential market and asset- backed securities.
The outlook: Staying strong
“Cycles don’t die, something kills them,” is a familiar market saying. We agree, and expect the economy to remain strong over the next 12 months.
The New York Federal Reserve puts the chance of a recession 12 months ahead at less than 10 percent.⁸ A Federal Reserve of Atlanta Index finds that businesses expect inflation in the year ahead to be 2.2 percent, a level that doesn’t make markets nervous.⁹
What could end our economic expansion? An overly aggressive Federal Reserve is one possibility. Corporate debt is another. The end of QE on the global level will likely become a headwind. Or an unanticipated economic threat could emerge.
Also, the market appears to have priced in a Democratic takeover of the U.S. House of Representatives. If that happens, we will likely return to gridlock reminiscent of the Obama administration.
Regardless, we are optimistic and expect to reach the third quarter of 2019 in the midst of the longest economic growth streak in our country’s history.
