The year 2020 includes two “2”s and two “0”s. Could there be a message in that unusual coincidence? As an amateur numerologist who also happens to be an economist, I’m thinking that the number 2020 strongly implies zero chance of a recession, with real GDP growing around 2.0% while inflation remains just below 2.0%.
That just happens to be my outlook for 2020. Though I would never say “never” when it comes to predicting recessions; they are always possible. But I don’t see a recession in this year’s U.S. economy. That’s because credit crunches invariably cause recessions. With the major central banks on course to increase the sizes of their balance sheets in 2020, a credit crunch seems highly unlikely. Will 2020 turn out to be much like 2019 for the economy and financial markets? Consider the following:
1. Political assumptions: My economic and market outlook assumes that geopolitical tensions abate in 2020 from last year’s concerns about U.S. trade relations with the rest of the world, the upheaval in Hong Kong, and Brexit.
Then again, things could all get worse in the coming year. The Middle East is likely to be more chaotic than usual following the U.S. assassination of Qassem Soleimani, Iran’s top general on Friday. The main risk, of course, is that Iran retaliates in ways that cause the price of oil BRN00, +1.25% to soar to levels that trigger a global recession. For now, I’m assuming that Iran won’t up the ante to that extent, given that the current occupant of the White House has demonstrated a willingness to respond with lethal force to any provocations from Iran.
Politically, the U.S., 2020 is likely to be just as acrimonious as it was 2019. Nevertheless, the U.S. economy continues to perform well despite all the noise coming out of Washington. My working assumption is that there won’t be a radical regime change in the White House at the beginning of 2021, i.e., President Donald Trump will get a second term. Yet no matter who wins the presidency, the checks-and-balances system of government invented by our Founders continues to work relatively well.
2. Real GDP: On a year-over-year basis, real GDP growth in the U.S. has been hovering around 2.0% since the first quarter of 2010 (Fig. 1). Since then through the third quarter of 2019, growth has ranged between a low of 0.9% and a high of 4.0% (Fig. 2). I am projecting that real GDP will increase 2.5% this year, a bit better than last year’s 2.3%.
I expect that real consumer spending will increase 2.5% this year, the same as last year. A slowdown in hiring as a result of a tight supply of workers should be offset by better growth in real wages, if productivity growth rebounds. I also expect the pace of growth in real capital spending to double to 4.0% from 2.0% last year as trade uncertainties and recession fears diminish. There is also likely to be a significant swing in residential fixed-investment in real GDP from -1.3% last year to 4.3% this year.
3. Productivity: The surprise in 2020 is likely to be that a tightening labor market boosts productivity, which would allow nominal wages to continue increasing faster than consumer prices. The resulting increase in real wages should bolster consumers’ purchasing power and fuel consumer spending growth. I am projecting an increase in non-farm business (NFB) productivity growth from 1.7% last year to 1.9% this year.
Growth in inflation-adjusted NFB output closely tracks growth in real GDP (Fig. 3). Actually, the former has been slightly outpacing the latter since mid-2010. NFB productivity growth has been fluctuating between 1.0% and 1.8% year-over-year since the start of 2017. It was 1.5% during the third quarter of 2019.
Productivity is one of the two variables that determines real output growth. The other is NFB hours worked, which rose just 0.9% year-over-year during the third quarter of 2019, little changed from the second quarter’s 0.8%, which was the weakest pace since the second quarter of 2010. The tightening U.S. labor market is weighing on the supply of labor.
In other words, real GDP growth might be about the same in 2020 as in 2019, but more of it is likely to be based on productivity than labor input. That would be a positive development for keeping inflation down, while boosting real wage growth and the profit margin. It would be a win-win-win situation for sure.
4. Inflation: In my 2020 outlook, inflation remains dead or at least in a coma for another year. I am predicting a core PCED inflation rate of 1.8% this year, the same as last year (Fig. 4). The major central banks are likely to persist in trying to offset the structural and powerful deflationary forces — resulting from global competition, technological innovation, aging demographics, and excessive debt — with ultra-easy monetary policies. They should continue to avert deflation but be frustrated by their inability to achieve their 2.0% inflation target.
5. The Fed and interest rates: In my scenario, the Fed is likely to remain on hold through this year’s presidential and congressional elections. In a press conference last October, Fed Chair Jerome Powell said: “I think we would need to see a really significant move up in inflation that’s persistent before we would consider raising rates to address inflation concerns.”
So the federal funds target range should remain 1.50%-1.75% through the end of this year (Fig. 5). In my outlook, the 10-year U.S. Treasury bond yield TMUBMUSD10Y, -0.44% should range between 1.50% and 2.00%.
6. Rest of the world: I expect somewhat better growth overseas during 2020 than was the case in 2019. The “peace dividend” from the de-escalation of Trump’s trade wars should benefit global growth. So should yet another round of ultra-easy monetary policies from the major central banks.
The latest data aren’t there yet. The eurozone’s flash M-PMI remained weak at 45.9 during December (Fig. 6). On the other hand, the NM-PMI remained above 50.0 at 52.4. The good news is that passenger car registrations in the European Union (EU) have been ticking up over the past three months through November, based on the 12-month sum of unit sales (Fig. 7). However, on the same basis, automobile sales in both the U.S. and China continued to weaken during November to the lowest since July 2015 in the U.S. and the lowest since June 2016 in China. Auto sales in China, the EU, and the U.S. combined totaled 56.4 million units over the 12 months through November, down 7.7% from a record high of 61.1 million units during August 2018 (Fig. 8).
U.S. economy II: Curve balls in 2020? For contrarians, the problem with my outlook for 2020 is that it is probably close to the consensus outlook. The big surprises last year have been mostly bullish for the stock market. The Fed pivoted from warning us during the fall of 2018 about the prospect of three or four rate hikes in 2019 to actually cutting the federal funds rate three times last year. Trump escalated his trade wars earlier last year, but has been de-escalating them in recent months. Also earlier last year, widespread fears that the inverted yield curve was signaling an imminent recession have abated as the yield curve spread turned positive as a result of the Fed’s third rate cut last year at the end of October.
The two biggest surprises this year would be a rebound in inflation and/or a recession:
1. Inflation risk: A rebound in price inflation is long overdue according to the Phillips curve model. Perhaps the model will finally work in 2020 as a tight labor market boosts wage inflation, which then boosts price inflation.
In fact, the Phillips curve model is finally working to explain rising wage gains, as the jobless rate has been below 4.0% for the past 10 months and for 16 of the past 17 months (Fig. 9). Average hourly earnings for production and nonsupervisory workers rose 3.7% year-over-year during November, the most since February 2009.
Yet there’s no sign that rising labor costs are boosting the core PCED inflation rate so far (Fig. 10). That’s because productivity growth is offsetting much of the increase in the Employment Cost Index, which is keeping a lid on the core PCED inflation rate (Fig. 11). The happy outcome is that real wages are growing without putting any upward pressure on prices or downward pressure on profit margins.
2. Recession risk: The other surprise relative to the current consensus outlook would be a recession in 2020. I’ve argued that the ultra-easy monetary policies of the major central banks are deflationary because they are enabling zombies (i.e., supply-side companies that should be out of business) to stay in business, while two to three consecutive decades of easy money have dulled the stimulative impact of those policies on demand-side borrowers.
Historically low interest rates are causing investors to reach for yield, while paying less attention to credit quality. The result has been that of the $7.1 trillion in U.S. nonfinancial corporate debt (including bonds, loans, and revolving credit) at the start of this year, $2.9 trillion was rated “BBB” (i.e., only one grade above junk), while $2.4 trillion was rated as junk, according to S&P Global’s May 2019 report, “U.S. Corporate Debt Market: The State Of Play In 2019.”
It’s not too hard to imagine that this pile of dodgy debt could set the stage for a credit crunch, which would bury the walking-dead corporate zombies, forcing them to shut down their capacity and to let go of their workers. The good news is that unlike 2008, the banks are in great shape. Furthermore, rising defaults by nonfinancial corporations may not cause a credit crunch if distressed assets funds act as a shock absorber in the capital markets as they did during the 2015 crunch.
In any event, for now the zombies are safe. The central banks continue to pump lots of liquidity into the global financial markets stimulating lots of reach-for-yield demand for the dodgy credits. It could all end badly, but that’s not likely to happen in 2020.
Stocks: Meltup in 2020? Another risk is that investors could conclude that the latest crisis in the Middle East won’t cause a recession. In this case, there might be nothing to fear but nothing to fear. That could lead to a market meltup. When the S&P 500 SPX, -0.71% rose to my 3100 target for 2020 on November 15, 2019, I started to consider the possibility of a melt-up scenario involving an advance to my 3500 year-end 2020 target well-ahead of schedule in early 2020. We may be experiencing that meltup now, given that the S&P 500 is already above 3200. Another 8% gain would put the S&P 500 at my 3500 target. Then again, the Middle East situation could avert a meltup for awhile.
I have been keeping a diary of stock-market panic attacks since the start of the current bull market. By my count, there have been 65 of them so far, followed by 65 relief rallies (Table of S&P 500 Panic Attacks Since 2009). The latest one occurred in August 2019. The S&P 500 has been making new record highs in recent weeks as investors have been relieved by the de-escalation of Trump’s trade wars, the diminishing risks of a global recession, and the prospect of more easy central bank policies in 2020. We should soon find out if Iran will cause panic attack No. 66, keeping in mind that the previous ones were all buying opportunities.
Bonds: Lower for longer? Given my outlook above, I believe that the 10-year U.S. Treasury yield will remain subdued between 1.50% and 2.00% through the end of next year. Credit-quality spreads should remain tight as long as recession fears don’t make a comeback next year. Helping to keep U.S. yields low are the slightly negative yields on comparable German and Japanese bonds. I don’t expect that real growth and inflation will surprise to the upside and push yields higher in Germany and Japan.
Currencies: Less mighty dollar? The U.S. trade-weighted dollar DXY, -0.24% has had a great run since the summer of 2011. It is up 33% since then. It may not have much more upside, but I don’t see much downside either. Usually, the dollar is strongest when investors overweight U.S. investments in a global portfolio (i.e., they “Stay Home” in the U.S.). It is weakest when investors underweight U.S. investments (i.e., they “Go Global”).
As I began to observe last October, stocks are cheap overseas compared to the U.S., and the outlook for the global economy is improving in 2020. That said, the U.S. still looks like the best environment for long-term investors seeking a diversity of major world-class industries with lots of market cap.
Ed Yardeni is president of Yardeni Research Inc., a provider of global investment strategy and asset-allocation analyses and recommendations. Institutional investors may sign-up for a free trial to his research service. Yardeni is the author of “Predicting the Markets: A Professional Autobiography.” He is completing his next book, “Fed Watching For Fun and Profit.” Follow him on LinkedIn, Twitter and his blog.
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