Bottom Line The U.S. economy is experiencing a sharp dichotomy between relatively heathy consumer metrics and undeniably weak manufacturing trends. The financial markets have discounted this Jekyll & Hyde distinction. Benchmark 10-year Treasury yields have plunged from 1.95% to 1.75% over the past fortnight, reflecting the weaker manufacturing news. But the S&P 500 has surged nearly 10% since early October, pricing in the healthy labor market and consumer spending. The index has breached our long-standing 3,100 target price for year-end 2019. Our full-year 2020 price objective remains at 3,500.
Inflation remains benign, with the core year-over-year (y/y) PCE and CPI indices at 1.7% in September and 2.3% in October, respectively. That has allowed the Federal Reserve to cut interest rates three times over the past several months. We expect the Fed to stay on hold with the upper band of the fed funds rate at 1.75% for at least the next year, absent an exogenous shock.
Those lower interest rates have sparked a recent resurgence in housing, and the labor market has remained solid through October. Many of the confidence metrics we monitor (including University of Michigan consumer sentiment, NFIB small business optimism and the Conference Board’s consumer confidence index) were at multi-decade cycle highs last year, a point from which they plummeted. The good news is that they all troughed in September 2019 and have begun to firm. Consequently, Back-to-School retail sales were strong with a y/y gain of 4%, and we’re expecting a healthy Christmas encore, with estimated gains of 4-4.5%.
The fly in the proverbial ointment is across-the-board weakness in manufacturing, and there are three contributing issues. First, the trade and tariff war with China has been dragging on for 19 months and the uncertainty has had a negative impact on CEO confidence, corporate spending, productivity and economic and corporate-profit growth. But we may see a skinny “Phase One” agreement signed before year-end, which could allow this cloud to begin to dissipate.
Second, the GM strike, which started Sept. 15 and affected some 48,000 United Auto Workers, was settled on Oct. 25, so we should see some relief into year-end.
Finally, the lingering Boeing problems with their 737 MAX jet, which has been grounded since March 2019 in the wake of two fatal crashes, may be resolved in coming months. The U.S. Federal Aviation Administration must approve the company’s proposed software fix and pilot retraining.
As a result, these manufacturing woes may prove transitory, and the ISM manufacturing index, which hit a 10-year low in September, turned higher in October. We still see no risk of recession on the horizon before the first half of 2021, at the earliest.
Tweaking our GDP forecasts The equity and fixed-income investment professionals who comprise Federated’s macroeconomic policy committee met yesterday to discuss the domestic and global economic landscape:
- The Commerce Department flashed third-quarter 2019 GDP at 1.9% (versus 2% in the second quarter), as a strong consumer and positive trends in government spending and housing offset weakness in corporate capital expenditures (capex), net trade and inventory restocking. We were at 2%, the Bloomberg consensus was at 1.6% and the Blue Chip consensus and the Atlanta Fed’s GDP Now estimates were both at 1.8%.
- We trimmed our fourth quarter of 2019 GDP growth estimate from 2.3% to 2.1%. The Blue Chip consensus estimate declined from 1.8% to 1.7% (within a range of 1.2% to 2.1%). We still expect a solid 4-4.5% gain in Christmas spending this year compared with last, but the timing and terms of a possible trade truce with China remain uncertain. Although the GM strike was settled last month, Boeing’s problems continue, which will be an additional drag on manufacturing activity.
- We kept our full-year 2019 forecast unchanged at 2.3%. The Blue Chip consensus estimate remained at 2.3% (within a tight range of 2.2% to 2.3%).
- We lowered our first-quarter of 2020 estimate from 2.4% to 2.2%, as we’re bracing for the fourth brutally cold and snowy winter in the past five years. The Blue Chip consensus remained at 1.7% (within a range of 1% to 2.3%).
- We expect an upturn in manufacturing activity in the second quarter, in part due to stronger export volume to China, and a healthy consumer during Easter. So we raised our second-quarter of 2020 estimate from 2.6% to 2.8%. The Blue Chip estimate increased from 1.7% to 1.8% (within a range of 0.9% to 2.6%).
- We are expecting a re-acceleration of economic activity in the back half of 2020, so we raised our third-quarter of 2020 estimate from 2.5% to 2.6%. The Blue Chip estimate increased from 1.6% to 1.7% (within a range of 0.7% to 2.2%).
- We also increased our fourth-quarter of 2020 estimate from 2.5% to 2.6%. The Blue Chip estimate remained at 1.6% (within a range of 0.5% to 2.3%).
- We kept our full-year 2020 GDP growth estimate unchanged at 2.4%. The Blue Chip estimate increased from 1.7% to 1.8% (within a range of 1.3% to 2.1%).