The freight train has begun to slow

The freight train has begun to slow

Friday, December 28, 2018 By Kermit Baker from Floor Covering Weekly

This coming summer, our economy will celebrate its 10th anniversary. In doing so, it will become the longest economic expansion in the post-World War II era. As this expansion has gotten older, it has seemingly gotten even stronger: our gross domestic product has averaged close to 4 percent growth over the past two quarters when annualized, and the national unemployment rate is below 4 percent, close to a 50-year low.

Despite the recent strong economic indicators, there are growing signs that the economy may be entering a slowdown over the coming quarters. Indicators that track the leading edge of our economy –- things like new business formations, changing commodity prices, growth in real estate loans, and initial claims for unemployment insurance – generally have been weaker recently. The ECRI Weekly Index of Leading Indicators, an index held in high regard by economists for its ability to predict the future direction of the economy, peaked last February and has slowly declined since.

What’s been happening that is causing this slowdown? Consumers, who account for about 70 percent of economic activity, are feeling quite comfortable with the direction of the economy at present. Unemployment is low, inflation growth is modest, wages are finally beginning to increase, and the value of their homes is rising. Businesses, on the other hand, seem much more concerned. Businesses were feeling good entering 2018 according to The Conference Board’s CEO Business Confidence Index, but business confidence levels dipped in the second quarter, and then dropped more sharply in the third. Concerns seem to center on a broad international economic slowdown, coupled with growing threats of tariffs and counter-tariffs that have the risk of developing into a full-blown trade war. As a result, businesses have become more reticent to move ahead with their capital spending plans. Growth in business investment spending, which was at a 5 percent pace last year and 10 percent through the first half of this year, dropped sharply in the third quarter to less than 1 percent growth.

The residential sector also has seen signs that market conditions are easing. Sales of existing homes have been very disappointing in this recovery. So far this year, homes sales have been declining from 2017 levels. The slowdown in home sales has begun to freeze the residential construction and improvement market. Housing starts nationally declined in the third quarter relative to the second quarter, and likely won’t even reach 1.3 million this year. Even the overperforming home improvement market seems to be feeling these headwinds as the pace of growth is projected to slow next year according to the Leading Indicator of Remodeling Activity (LIRA) from Joint Center for Housing Studies of Harvard University.

So, how can we tell if the economy is just entering a temporary soft-spot or potentially moving into an economy-wide recession? There are three economic indicators that have proven to be useful predictors of recessions. The first is stock prices; a 20 percent drop in stock prices often leads a broader economic downturn within 9-12 months. Currently, the stock market is sending off warning signals, but hasn’t yet hit this threshold. The second is interest rates and the yield curve, which is the comparison of interest rates at different maturities. When the yield curve “inverts”, meaning that longer-term rates fall below those with a shorter-term, generally an economy-wide recession materializes over the next 6-9 months. The final indicator is the jobs market. When payrolls begin to decline a recession is sure to follow. The only problem with this indicator is that it doesn’t provide much of a lead over an impending recession. So, it’s still a bit early to tell whether this expansion is ending, but it’s a good time to start watching the indicators much more closely.

Kermit Baker is the senior research fellow for the Joint Center of Housing Studies at Harvard University. He may be reached via e-mail at [email protected]