Can A Strong US Consumer Maintain Sufficient Global Economic Growth For Markets to Outperform?
The U.S. consumer continues to be the backstop for the global economy as unemployment remains at record lows, debt service obligations reach a 45 year low and savings rates close in on 8 percent. Retail sales have now risen for six straight months and look to accelerate into the 3.5 to 4.0% range which is very healthy. Offsetting this robust picture is the trade war with China, which continues as a tax on the U.S. consumer and, as expected, has diminished exports and CEO appetite for increased capital spending leading to the first manufacturing recession in years.
The doomsday scenario is a manufacturing recession that leads to rising unemployment in industry spilling over into the mainstream economy which is today largely dominated by services. Wage gains remain stagnant despite higher prices on imported goods from U.S. trade wars. New tariffs planned for December are expected to cost an average American family anywhere from $1,000-$2,000. Credit card debt is already at around $1 trillion in the U.S. This year we are starting to see banks start to write down bad debts at the fastest rates since 2012.
Economic growth is expected to improve into 2020 with the Federal Central Bank lowering interest rates and adding excess reserves to the banking system once again. This increase in liquidity should find its way into the global economy alleviating stress in international financial markets and ultimately end up weakening the U.S. dollar. An end to the U.S./China trade war would be a meaningful development for the global economy as supply chain disruptions are mitigated, tariffs are removed and Corporations can begin to renew spending on capital projects.
Despite Trump’s assertion “trade wars are easy”, it appears the U.S. has been on the losing end of the trade war as China has been able to find alternative and less expensive supplies of the raw materials and agricultural products they have stopped buying from the U.S. However the U.S. has, as yet, been unable to substitute alternate sources of supplies for the manufactured goods Americans buy from China (such as much of the consumer electronics that are only made in China) which now have tariffs from the Chinese. It takes time to relocate manufacturing to lower cost regions and there remains much to do. The end result is American consumers are suffering from tariffs and Chinese consumers are not.
Much optimism prevails around the economy continuing to hold with the promise of lower rates. Given unemployment is low and the consumer remains strong it is incredible that this is even on the table as lower rates will just encourage more debt. The debt problem is already at the point where the dream of “growing our way out of it” is past its “best before date”. Raising interest rates, even modestly, immediately causes riot in the financial markets and economic activity to fade, creating outcry. The Fed “has blinked” and there is no way back. Inevitably they will lower rates again causing more debt to be accumulated ratcheting the system into a smaller corner with fewer options. In the end it will end either with failing growth and a debt deflation event or they will somehow manage to inflate their way out of it. Given the pile of debt that keeps burdening the economy dragging down economic growth, getting the economy to produce inflation is now like trying to get an overloaded plane to take flight. As we have said many times, you cannot fix the problem of too much debt with more debt. At some point it is necessary to retrench and find a way to pay it back. We sense that day is fast approaching.
The global economic picture may stop getting worse, but it is not getting better. Global growth is now at 2.3% according to JP Morgan, which is anemic at best. The damage of trade tariffs has caused a global freeze in capital expenditures and falling profits and this is likely to continue until something major changes. We do not think lower rates will help abate this situation created by an isolationist President of the free world. China is also slowing down and unlikely to be able to pull the world out of this mess. Threats of tariffs already in place and more to come will not encourage companies to invest.
As investors we cannot wait until it is announced in the newspapers as by then it will be too late. Positioning portfolios with a conservative defensive bias has never been more important.
A lot would need to happen to bring sustained optimism back to the markets and a change in our defensive position: a U.S.-China pact and the end of senseless expensive trade wars, a Brexit that will not cause excessive carnage to the parties involved, and more global accommodation by central banks only with conditions of lowering current and future debt burdens. None of this is likely to happen in the near future so we will continue to climb the wall of worry.
The Summerhill Team