Perpetual Growth Doesn’t Exist and a Recession Approaches
It can’t be denied. The economic statistics, full of job growth numbers and gross domestic product (GDP) growth, say the United States economy has grown at levels not seen since the 1960s. But as you ponder that blissful prospect, consider that a recession is right around the corner.
U.S. economic growth has come at the expense of debt, which low interest rates have made more palatable.
There’s a catch though.
The U.S economy has become dependent on low interest rates. But lately, the Federal Reserve has not been wavering from increasing those rates. That could tip the balance from growth to another recession.
There’s no doubt that suggestions of an imminent recession seem paradoxical if not totally delusional. Clearly, the United States is enjoying an intense period of recovery.
The macroeconomic data, the numbers, have not been this good in years—or in decades. But looks are deceiving.
The economy has been brilliant for some, which has helped skew the numbers toward the bullish side. Moreover, many have been taking President Donald Trump too literally. They think he has somehow, in less than two years in power, put America on a path to perpetual growth.
In fact, the real engine of growth, the motor that has driven the stock market’s excellent performance and apparent resilience to shocks, doesn’t come from the White House. It doesn’t come from Congress either. For that to happen, politicians would have to discuss some kind of policy.
That has been largely absent from Washington, consumed as it has been with partisan bickering and grand inquisitions about foreign plots to hijack American democracy.
Rather, the so-called “invisible hand” of the market could not be more apparent. As it happens, there are two such hands, and they both belong to the chair of the Federal Reserve. The Fed has pumped the markets with liquidity and a sprinkle of low interest rates.
Trump merely added a bit of nitrous oxide, in the form of lower corporate taxes, which had stocks peeling out in overdrive.
Nitrous oxide, unlike a turbocharger, has an explosive effect but then runs out. The effect of the tax cuts will fizzle out by the third quarter of 2019.
Gridlock and the End of the Fiscal Stimulus Effect
Still, even if Trump manages to pull off more corporate tax cuts—a tough prospect politically, given the gridlock-like scenario that the midterm elections have produced—there’s the Federal Reserve issue.
The Fed’s interest rate increases will inevitably drive investors away from the high-risk game of equities to more manageable government bonds or precious metals.
Interest rate increases will produce the same effect on the financial markets that a ballast has in a submarine; they will sink stock valuations.
The combination of higher interest rates with the waning fiscal stimulus effect, as has happened in 2018, will gradually discourage speculation in the markets.
In other words, in 2019, the economy will experience a veritable reversal of the two key elements that rallied investor sentiment about the U.S. economy in 2017 and 2018.
Reversal of Fortune in 2019
You need not look too far to notice the first hints of an economic slowdown, despite the indicators continuing to signal growth.
Higher interest rates have been damaging the real estate and large consumer goods businesses.
Moreover, rather than invest the surplus from Trump’s tax cuts, corporate investment has not increased. Many corporations have engaged in frenzies of stock buybacks rather than in investing in true expansion.
I expect at least two more rate hikes between now and the second half of 2019. Many investors, even those who have managed to retain enthusiasm, will have already started to pull back from equities.
As for the markets, 10-year Treasuries should continue to hover around 3.2%, pushing stocks to the sidelines.
The Federal Reserve is not expected to raise interest rates again until December. But it’s just a matter of time, months maybe, before the Fed’s interest rate “normalization” process could push the U.S. economy into a recession.
In fact, you’ll be glad that the Fed will have increased interest rates because, at least that way, its members will have a tool to control that recession. They might then lower the rates to do so.
Many market participants may start to turn their noses up at the economy, fueling the kind of volatility we saw in October.
Other Than Corporations, Few Benefited From Fiscal Reform
Moreover, ordinary Americans may discover that they have benefited little, if anything, from the low interest rates and tax cuts.
This will happen when the financial news merry-go-round will be forced to adopt less bombastic tones. And markets run on psychology, perhaps even more than they do on earnings. How else could one explain the success of Tesla Inc (NASDAQ:TSLA)?
As the tap of “quantitative easing” (QE) shuts down, reality will set in. The reality is that the White House’s fiscal policy, with the popularity-driven tax cuts that Trump launched in December 2017, may have run its course.
Yes, the tax cuts for companies have allowed them to increase their earnings and thus record strong profit growth. Admittedly, as a market skeptic, I recognize that S&P 500 profits went up by over 20%, according to FactSet Research Systems Inc. (NYSE:FDS). That’s almost twice as much growth as in 2017.
But, at least in 2018, the trade war with China was only in its infancy. In 2019, things could get interesting very quickly. There is some $250.0 billion worth of goods under new duties now.
Trump may try to settle a bilateral deal with Beijing, but there’s no indication it will pass.
And then there is the ever more aggressive foreign policy. The much-discussed peace overtures toward North Korea have failed to produce concrete results. U.S. and South Korean troops continue to conduct their war game exercise, angering Pyongyang.
Meanwhile, the U.S. has also restored all sanctions against Iran, pushing that country to the brink of economic collapse. It also pushes the U.S. toward another (and this time especially disastrous) war in the Middle East. Interest rates may be the least exciting and most innocuous of all the risks that are building.
A recession seems inevitable.