Outlook and Market Review - Third Quarter 2019

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The U. S. economy grew at a 2.1% pace in the third quarter, based on the revised estimate by the Bureau of Economic Analysis. Second quarter growth was 2%. In the third quarter, consumer spending continued to drive GDP growth with only modest contributions by government spending. Net private investment continues to be dormant even though costs of capital are very low and firms have accumulated internal cash that could be put into real asset investment. While overall consumer confidence remains high, businesses are more cautious due to vitriolic politics, vocal anti-business sentiment, and uncertain global economic conditions.

The labor markets continue to shine with no downside in sight. Job creation in November was an astounding 266,000 new jobs following very strong payroll expansions in both October and September. The three-month moving average job creation ending in November was 205,000 per month. The unemployment rate fell to 3.5% while the labor-force-participation rate held steady. Wages continue to grow at a modest 3.1% but at a faster pace than productivity, resulting in higher unit labor costs. Profit margins are squeezed due to higher unit labor costs and an inability to raise prices in a globally competitive market. Even so, earnings announcements have surprised on the upside and equity values remain near all-time highs.

The long awaited recent passage of the United States, Mexico, and Canada Trade Agreement (USMCA) as well as the recent agreement to a limited China deal offer a more promising view of trade conditions going forward. Lower interest rates linked to Fed decisions in the second half of 2019 also offer support for continued expansion in 2020. Household budgets are in good shape and higher equity values have contributed to overall wealth. On the downside, as the workforce ages and gets closer to retirement the tendency to save rather than spend puts some downward pressure on consumption spending.

Manufacturing continues to struggle from more limited international trade markets, rising unit labor costs, and the strong U.S. dollar that hurts exports and makes competitive imports cheaper. Manufacturing fell 1.5% in October and capacity utilization fell to 76.78% compared to an all-time high of 89.39%. The PMI index, a forward looking indicator of production and manufacturing reached 52.6 in November following a 51.3 reading in October, suggesting expansion in factory activity. While the three month improvement in the index at the end of 2019 is not necessarily enough to suggest a turnaround in the manufacturing sector, it is promising.

Inflation remains low and below the Fed target of 2% for the Core PCE. On a year-over-year basis the Core PCE gained only 1.6% while the Core CPI increased 2.1%. The CPI normally runs ahead of the PCE. Low inflation rates offer the Fed room to keep interest rates low and continue to follow more expansionary policies. Global competition and the strong value of the dollar should keep a lid on inflation going forward, even though the 3.5% unemployment rate suggests a full employment economy.