Aug 14, 2018

Are the Markets Signalling Slower Growth Ahead?

By Gene Balas

Photo credit: Getty Images

By most accounts, the economy is growing robustly, with the broadest measure of economic growth, gross domestic product (GDP), expanding by 4.1% in the second quarter, the best reading in several years, according to the U.S. government’s Bureau of Economic Analysis. Unemployment is at very low levels, and companies now have a different type of problem: finding enough qualified workers to fill open positions. While signs of strong economic conditions dominate the headlines, we take a deep dive into the data to see what might be ahead.

After all, the markets are forward-looking. And some indicators may point to slower growth ahead, quite possibly from the effects of tariffs. The threat of tariffs is not really a mathematical calculation; it’s the effect on psychology, particularly of business leaders who must decide whether to expand and hire or simply wait and see.

Analysts who talk to those corporate leaders on an ongoing basis hear those concerns, and some investors have signaled a bit of caution, such as investing in bonds instead of stocks. For example, the yield curve has flattened, indicating investors may be a bit less optimistic about growth going forward. Even so, the yield curve had been similarly flat during part of the 1990s – a period of strong growth.

Yield Curve

And a flattening yield curve can instead be related to the massive central bank bond purchase program in the U.S., Europe and Japan. Even if bonds are no longer being purchased, by central banks simply keeping those bonds out of the traded markets, longer term interest rates are suppressed. And U.S. Treasury bond yields are correlated to (much lower-yielding) German bonds, given their arguably equivalent credit rating – and even directly to economic conditions in Europe.

Other indicators don’t point to economic growth that would slow to the point that the Fed reverses course and cuts interest rates. For example, measures of traders’ expectations where the benchmark short term interest rates that the Fed sets, show continued, gradual rate increases over the next several years.

However, the flattening yield curve is nonetheless correlated with manufacturers’ sentiment, with current measures suggesting that manufacturers, while still positive on balance, are becoming less so when looking at trends of the comparison of manufacturers’ assessment of expectations for business conditions six months from now versus their assessment of the present, part of a monthly survey of manufacturers by the Philadelphia Federal Reserve of companies in its district. As manufacturers have become comparatively less optimistic, the yield curve has flattened.

And some other measures do point to a slowing economy in coming periods, such as the extra yield typically demanded by investors in longer term bonds to compensate for interest rate risk vs. investing in short term instruments. Called the term premium, it is correlated with economic growth into the future, and currently it may also be signaling slower economic growth, as bond investors demand less compensation for risks such as rising inflation or interest rates.

Meanwhile, copper prices also provide useful information, and copper, unlike financial market instruments, is bought by companies that produce and build actual goods and structures. Its price drop in recent months is consistent possibly with slowing economic growth – and the potential for lower corporate profits. And share price weakness of shipping companies also correspond with slower economic growth.

This is borne out by surveys of companies, who cite uncertainty from tariffs and trade as a reason they are curtailing hiring and investment – with some multinationals even moving production to other countries from the U.S. for goods destined for export. This may avoid tariffs on shipments from the U.S. to certain markets, such as China, which have imposed tariffs on our exports.

An economist or analyst can mathematically calculate the amount of the tariffs, whether imposed or proposed, relative to the size of the economy and determine that, since the tariffs are not a large percentage of the U.S. economy, the economy would be unaffected. But businesses (and households) do not perform those calculations independent of their own mood or that of their customers. If a company is uncertain, it might very well hold off on investing or hiring, regardless of how big or small a percentage of the economy tariffs occupy that an analyst tells us is the case.

In the end, business and household decisions are made at the human level, even if aided by quantitative means. A damage to business confidence is friction, sand in the cogs of production that could threaten to slow economic growth. However, as with all things that pertain to human psychology, predictions become hard to make. It may be that business leaders set aside any concerns they may have, and the economy continues to grow, unharmed.

Or it could turn out that those less-optimistic data we examined earlier could, in the end, prove to have sent the correct message. In the meantime, we must continue to listen, carefully, to the signals presented us.


Source for data and graphics: Bloomberg, the Federal Reserve, the St. Louis Fed, Institute for Supply Management, Bureau of Labor Statistics, Bureau of Economic Analysis (Department of Commerce). Investing involves risk, including possible loss of principal, and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. The information contained in this piece is intended for information only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. Please contact your financial adviser with questions about your specific needs and circumstances. The opinions expressed in this article are those of the author and not necessarily United Capital Financial Advisers, LLC. The information and opinions expressed herein are obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital. Opinions expressed are current as of the date of this publication and are subject to change. Certain statements contained within are forward-looking statements including, but not limited to, predictions or indications of future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties. Indices are unmanaged, do not consider the effect of transaction costs or fees, do not represent an actual account and cannot be invested to directly. International investing entails special risk considerations, including currency fluctuations, lower liquidity, economic and political risks, and different accounting methodologies. © 2018 United Capital Financial Advisers, LLC. All Rights Reserved

Gene Balas

Gene Balas

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