A Mixed Bag

Recent economic data reports have continued to paint a mixed picture of the U.S. economy, with strength in consumer spending and a mild recession in manufacturing. On top of this, investors remain concerned about several issues, including global growth, geopolitical uncertainties, trade policy, and an inverted yield curve. However, stock market participants are generally hopeful that a trade deal will be worked out and that the Federal Reserve will come to the rescue. As summer comes to an end, we can expect investors to more seriously evaluate current conditions and the prospects for the remainder of the year.

The 2nd estimate of 2Q19 GDP growth was not much different than the advance estimate (a 2.0% annual rate, vs. 2.1% in the initial estimate). As in the advance estimate, growth was isolated in two sectors: consumer spending and government. Business fixed investment contracted at a 0.6% annual rate in 2Q19 (same as in the advance estimate), but weakness was pronounced in mining structures (which includes oil and gas exploration) and transportation equipment (likely reflecting transitional problems at Boeing). Corporate profits improved in the second quarter, but manufacturers’ profit margins are being compressed by tariffs (especially after the May 10 escalation). Residential homebuilding fell for the sixth consecutive quarter in 2Q19. Normally, that’s what you would see in a recession, but in this case, the problem is supply, not demand. The missing element in the housing recovery has been in start-up homes. Higher building costs (partly reflecting tariffs), a lack of skilled labor, and a scarcity of lots on which to build have constrained supply at the low end of the housing market, while strong demand has driven up prices, reducing affordability (despite a sharp drop in home mortgage rates). Residential fixed investment accounts for less than 4% of Gross Domestic Product, so the housing weakness isn’t critical to the outlook for overall growth, but it is a problem.

With personal consumption expenditures accounting for 68% of GDP, the strength of the household sector is key. The fundamentals appear sound. Job gains and wage growth should continue to support spending in the near term. The July data suggest that inflation-adjusted consumer spending is tracking at over a 3% annual rate in early 3Q19. Measures of consumer attitudes have been mixed. The Conference Board’s Consumer Confidence survey has a more direct measure of labor market perceptions, which have been robust. That’s missing (at least directly) from the University of Michigan’s Consumer Sentiment survey, where the August reported noted increased concerns about tariffs and trade policy. Press reports of the inverted yield curve, “recession,” and stock market volatility may have an impact on spending, but more at the high end.

On the global front, economic data have also been mixed, but generally soft. Canadian GDP growth for 2Q19 was reported stronger than expected (+3.7%), but much of that reflected a normalization in exports following earlier softness (GDP rose at a +0.5% in 1Q19). Many advanced economies reflect that same split as seen in the U.S. – that is, relative strength for consumer spending, but softness in manufacturing activity. New leadership is on the way in Europe (both for the European Union and the European Central Bank), but these are expected to be smooth transitions (note that both the ECB and the U.S. Fed will be led by lawyers, not economists). Brexit and Hong Kong are significant geopolitical risks. Japan and South Korea are fighting their own trade conflict. China’s current softness reflects more than trade tensions. Rising debt in that country has been a growing concern over the last decade. Trade tensions between the U.S. and China have spilled over to the rest of the world. Emerging economies appear unlikely to lead the global economy.