Dec 11 2019
Real GDP increased at an annualized rate of 1.9% in Q3 2019, marginally lower than the revised growth of 2.0% from the previous quarter, according to the Bureau of Economic Analysis (BEA). This increase is primarily a result of positive personal consumption expenditure (PCE), residential construction investment and government spending at the federal, state and local levels.
However, GDP growth was inhibited by private inventory investment and nonresidential construction investment. In response to slowdown concerns, the US Federal Reserve cut its federal funds rate twice in Q3 and once in October.
Consumer spending and labor
Over the previous quarter, the US economy has seen continued growth in employment and wages. In Q3 2019, the US economy added nearly 565,000 nonfarm jobs, according to the Bureau of Labor Statistics. This represents a sustained trend over several quarters, despite a correction to past employment figures at the beginning of the quarter. So far in Q4 2019, this pattern has continued, with 128,000 more nonfarm jobs being added in October alone. This brought the 12-month moving average job growth to 175,000.
While growth in employment has begun to slow, the continued addition of jobs across most industries remains a positive indicator for the labor market. The sectors with the most-notable job growth were in food and beverage services, financial activities and social assistance. Nonetheless, manufacturing employment took a hit during the same period. The main cause of this dip in manufacturing employment was motor vehicle manufacturing, an industry where there has recently been notable strike activity.
Continued labor market growth has kept the unemployment rate below 3.8% and encouraged continued growth in hourly wages. In Q3, the unemployment average was 3.6% after dropping to 3.5% in September, down from 3.7% in July and August. Over the past 12 months, average hourly earnings have increased 3.0%, reaching $28.18 in October 2018. This is a $0.06 increase from the end of Q3 2019.
While average hourly wages have increased, it has been at a slower rate than the overall economy. This has caused some concern among economists, as typically employees would have more negotiation power in this type of labor market. Many expect that this lag in growth is partially caused by reentrants into the labor force and the gig economy. Gig employees have significantly less negotiating power than other employment groups.
Nonetheless, this has led to continued consumer spending growth. As people make more money, they are likely to increase their spending. Overall, PCE has grown 1.1% over Q3. Services grew 1.1% over Q3, while non-durable goods grew by a similar 1.0%. Durable goods grew the fastest by 1.5% over Q3. Overall, PCE has increased $158.1 billion since Q2. Growth in PCE is primarily driven by Services, due to its large share of total PCE, which increased the most in dollar terms by $106.3 billion. Within services, housing and utilities, healthcare and food services and accommodations represent the largest components.
Construction spending is a leading indicator of business investment and consumer activity, as businesses tend to spend more on new construction and expanding capacity when it is believed that doing so will generate higher revenue and profit. However, construction trends have diverged in Q3, with nonresidential spending contracting as residential spending has spiked, indicating a relatively mixed economic outlook. Since May 2019, uncertainty regarding the short-term outlook has weighed on businesses’ sentiment, with trade tensions, Brexit and slowing global growth as key points of concern.
In Q3, nonresidential construction spending declined at a seasonally adjusted annual rate of 0.5%, with amusement and recreation, commercial and lodging construction driving the overall decline in the nonresidential market.
Conversely, lower borrowing costs, a resilient labor market and healthy consumer spending encouraged Home Builders (industry report 23611a) to pursue new projects. In Q3, the number of housing permits issued increased a whopping 12.9% during the quarter, resulting in residential construction spending being up 2.4% for the quarter. Nevertheless, trends from the end of Q3 and preliminary data from October suggest that homebuilders were likely overoptimistic, as building permits declined 2.4%. Furthermore, home prices began to decline at the end of Q3, which likely would not have occurred if demand had met homebuilder expectations in this low supply environment.
Despite three interest rate cuts in the last few months, mortgage rates have begun to increase again after reaching a trough in August, and consumers are not as optimistic about purchasing homes as homebuilders expected they would be. In fact, the “Good Time to Buy” component of the Fannie Mae Home Purchase Sentiment Index declined from 28.0% of respondents in September to 21.0% in October. The overall index also now sits at 88.8 in October, down from 93.8 and 91.5 in August and September, respectively.
Overall, total construction investment grew 0.6% in Q3, largely due to the strong growth in the residential market. However, with residential investment growth unlikely to rise again as it did in Q3, there is considerable downside in construction’s outlook. Still, any resolution to the trade impasse between China and the United States would be welcomed by businesses, and have the potential to boost nonresidential construction investment moving forward.
Financial markets experienced some volatility in Q3 2019. During the quarter, the equities market experienced trends that indicated investor sentiment was worsening. As a whole, holdings that are typically considered defensive performed better than cyclical holdings. Typically, investors “flee to safety” amid fear of a market correction. This is typically observed when holding, such as utilities and consumer staples, outperform typical growth sectors, such as consumer discretionary, technology and energy.
Many investors seemed concerned about the market having reached a peak, especially juxtaposed against trade tensions and geopolitical concerns that have significant effects on the market. In addition to these sectors performing well, some fled the equity asset class entirely in favor of gold, a store of value and a safe haven during times of economic upheaval.
Despite positive consumer indicators, inflation continues to grow but maintains a rate below that of the Fed’s 2.0% target. As of September 2019 (the end of Q3), the year-over-year inflation rate was 1.7%. This is a slight acceleration compared to Q2 2019, which ended with inflation of 1.5%. Although inflation has remained below the Fed’s target it has maintained an upward trajectory and even accelerated slightly over the third quarter of 2019.
Given these low inflation rates, the Federal Open Market Committee (FOMC) continued to cut interest rates during the second half of 2019; specifically, the FOMC cut rates on August 1, September 19 and October 31. The committee’s motivating factors were trade tensions with China, the global slowdown, low inflation and overall uncertainty. Nonetheless, the message the FOMC gave after their last meeting was more hawkish than expected, giving the impression that they would not be lowering rates further.
As expected, IPO activity cooled in response to the heightened uncertainty. In total, Q3 2019 saw 39 IPOs raising $10.8 billion. Furthermore, a disproportionate number of IPOs were filed in July when markets hit record highs and the Fed cut interest rates for the first time in over a decade. There were several big unicorns such as SmileDirectClub LLC, Peloton Interactive Inc., Medallia Inc. and Cloudflare Inc. to go public.
All in all, 62.0% of IPOs in Q3 were biotech companies and the aforementioned unicorn companies, a sign of initial investor appetite for growth. However, IPO activity slowed as the quarter progressed and is expected to remain muted in Q4, partly due to concerns and backlash associated with WeWork Companies Inc.’s planned IPO; in a worsening economic outlook, perceptions of companies that burn through cash rapidly and have not turned a profit have become more negative. This will likely weigh on big IPOs with similar profiles moving forward.
Similar to the IPO market, the merger and acquisition (M&A) market slowed significantly in Q3 2019; according to Mergermarket data, total M&A deal value in the United States declined from $514.4 billion in Q2 to $262.9 billion in Q3. Volume trends were similar, with the number of deals declining from 540 in Q2 to 440 in Q3. The declines occurred at nearly every level of deal size, though disproportionately more so with megadeals.
Technology, media and telecom (TMT) was the leading sector in both value and volume during the quarter, a trend that carried over from Q2. Notably, there was a significant slowdown in M&A activity from the defense and energy, mining and utilities sectors in Q3. Moving forward into Q4 and 2020 overall, slowing domestic and global growth will likely continue to characterize the economic landscape. Accordingly, divestitures will likely continue to be a key component of businesses’ strategies as they seek to traverse a shifting environment. Geopolitical concerns will also likely play a role in the coming months, as a resolution to the US-China trade war and Brexit would likely promote the flow of capital and proliferation of deals.
Amid a slowing global economy, fears of an impending recession have begun to mount. While it is impossible to determine whether the economy has entered recession until well after the fact, there are several leading indicators that can help fill in the gaps.
One leading indicator is an inversion between the yields on short- and long-term treasuries, often the spread between the 10-year and either three-month or two-year. Typically, longer-term treasuries have greater price sensitivity to interest rate changes, and therefore must yield higher interest rates to compensate investors for the added risk. When the yield curve inverts, short-term treasuries yield more than longer-term treasuries, an indication that investors believe economic conditions will deteriorate and that interest rates are likely to fall in the near future.
Despite first inverting in March, the 10-year to three-month yield curve inverted at the end of Q2 and remained inverted for most of Q3. Moreover, the 10-year to two-year yield curve inverted temporarily in August. While the length of time between yield curve inversions and ensuing recessions has fluctuated, the last five recessions have had recessions occur anywhere from six to 18 months after an inversion.
Another leading indicator is CEO confidence, in conjunction with the gap between CEO and consumer confidence. CEOs tend to make decisions taking into account a variety of information, both current and forward-looking. Conversely, consumers tend to be motivated by their immediate realities and not on issues where the effects are indirect such as tariffs. While CEO confidence tends to be systematically lower than consumer confidence, the gap between the two confidence indices tends to widen to its largest level when a recession is on the horizon. In Q3 2019, the gap between the two confidence indices reached 73.2 index points, its largest level in at least four decades.
While the exact onset of the next recession is not certain, it is clear that economic conditions have weakened. Geopolitical uncertainties, from trade tensions to an unsettled Brexit to a slowdown in the EU, have weighed on US businesses. In many ways, consumers have propelled the economy forward as other drivers of economic growth have slowed. Accordingly, without any material increase in the unemployment rate and an ensuing decline in consumption, the economy will likely continue to grow at a moderate pace. Once labor conditions do worsen, however, the longest economic expansion on record will likely finally come to an end.
Looking for additional coverage on US macroeconomic trends? Check out our previous Spotlight Report on Industry Insider for IBISWorld’s Q2 2019 Macroeconomic Update!
Edited by Sean Egan