If this month’s stock market volatility made you jittery about the economy, remember that the stock market should only ever make you jittery about the stock market.
“Just remember that the economy is not the stock market, and the stock market is not the economy,” said Gus Faucher, chief economist at PNC Bank.
“There is nothing to me that indicates the economy is going to enter a recession in the next few months,” Faucher said. “I believe we’ll see this become the second longest [economic] expansion in U.S. history, if not the longest.”
Faucher presented earlier this month during a meeting of the Harrisburg Regional Chamber of Commerce and Capital Region Economic Development Corporation (CREDC), where he stressed that the underlying fundamentals of the U.S. economy will continue on a strong trajectory.
Although noting that PNC’s analysis had been done before the stock tumble that started on Feb. 2, Faucher said the market was “overdue for a correction” as investors continued to pile earnings into stocks with the expectation that a low-interest environment would persist among bonds and other securities.
But stronger growth starting in mid-2016 put upward pressure on interest rates, with the Federal Reserve signaling more increases to its base lending rate, which should bump up borrowing costs across the spectrum.
Further, Faucher noted, tax cuts have put the federal government on a deficit course, with the U.S. Treasury having to issue more and more bonds to compensate for lost federal income, forcing rates on other securities up in order to compete with bond offerings.
But interest rates won’t suddenly go sky-high overnight.
“These rates, although they’re moving higher, are still very, very low on a historical basis,” Faucher said. The sudden stock selloff may well be a function of investors forgetting just how rock-bottom most rates have been since the recession.
In the last two years, 3-month Treasury bills have shot up from about a quarter-percent interest to about 1.4 percent now. Likewise, 10-year Treasury bonds shot from about 1.5 percent interest to 2.5 percent over a few weeks in mid-2016. But both of these rates, by historical standards, are still very low.
Stock prices will also be buoyed by companies pumping a significant amount of their savings from the federal tax cuts into buying back stocks and raising shareholder dividends.
“Businesses are already very profitable, and businesses have been using a lot of that cash to pay dividends and buy back their shares in order to raise their stock price,” Faucher said. “While you will see some investment, my expectation is they will use most of the profits from the tax cut to boost their share price.”
In other words, while the federal tax cut will help stabilize the stock market, it’s unlikely that the era of low business investment will change significantly, with inflation-adjusted asset investment by businesses tracking at about 2.25 trillion per year, as opposed to $2 trillion pre-recession.
But consumer signals remain high. Consumer spending has held steady at roughly a 3 percent year-to-year growth projection since 2014. Debt levels have been climbing slowly since that time as well, indicating positive expectations by consumers on their ability to keep paying their bills – although consumer debt is not back to its pre-recession levels, which is likely a good thing.
Quit rates among employees are also trending gradually upward, indicating workers’ confidence in finding a new job. Monthly job creation numbers have been dropping off over the past year, although Faucher does not see that as a problematic indicator.
“It has been slowing but that’s more of a difficulty in finding labor than from lack of demand,” he said. “We only need to create about 90,000 jobs per month in the U.S. to keep up with natural growth in the labor force.”
With all of these signals pointing toward continued, steady improvement, what should businesses be on the lookout for?
The major indicator of economic troubles, Faucher said, is accepted by most economists to be a phenomenon known as the “inverted yield curve.”
This occurs when short-term investments produce greater rates of return than longer-term investments. In a healthy economy, committing money for a longer term should demand a greater interest rate. But if long-term investment proceeds fail to keep up with short-term investments, this typically indicates a heightened level of uncertainty and an impending downturn.
Short-term rates have risen faster than long-term rates in recent months, Faucher noted, although the yield curve has not inverted – and will not for at least another year, even under the most adverse conditions.
“We have seen the yield curve flatten,” Faucher said. “I don’t think it’s going to invert, but that’s something to watch out for. If it does invert, it’s an indication that a recession may be coming.”
The other point of uncertainty in an otherwise steady economy is politics – specifically, Faucher said, immigration, given that recent drops in some indicators, such as job creation, are due to a lack of new workers.
“If we restrict immigration, it could lead to slower economic growth in the U.S.,” Faucher said.
This is one of the several significant uncertainties on the political side since Donald Trump was sworn into office, Faucher said. While Trump could present significant opportunities for change that will boost growth, he also presents equally major downsides.
“There are a lot of potential opportunities under a President Trump, but a lot of bigger pitfalls,” Faucher said. “The risks are balanced but the risks are larger, both upside and downside, with Trump than with a more sedate president, if that’s the way to put it.”