With 15% gains in the major stock indices (Nasdaq 28%) stocks are on pace for their 4th best year since 1999. Precursors of accelerating economic growth abound in 2017, reflective of the rebounding earnings and future expectations. The stubbornly sluggish US GDP continues to hover near its 2.1% post mortgage bubble 7-year expansion cycle. Underlying proxies of manufacturing and service sectors are approaching historic rates of expansion with record demand for job seekers. Factories are struggling to find capacity as New Orders and Shipments are outpacing depleted customer inventories. Today’s 3.0% GDP report for the 3rd quarter, following the 2nd quarter pace of 3%, is a strong sign that real growth is finally percolating to the economy’s bottom line GDP.
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US Manufacturing as measured by ISM’s Purchasing Managers Index (PMI) hit a 13 year high in September, one of the most comprehensive rates of expansion ever recorded. Should legislative winds provide corporate tax cuts and an estimated Trillion repatriation of foreign earnings in 2018, then there may yet be hope for GDP growth rates above 3% despite the impedance of a tight labor pool. Lower business taxes here would boost global growth as other countries follow suit.
The pace of shipments is at a new high is causing a strain in logistics and slower delivery times. Inventory accumulation gave a boost to 3rd quarter GDP, but New Order expansion and heavy backlogs hint that inventory building may continue.
The personal consumption and the service sector has accounted for the lions share of GDP growth since 2009, but lately, the missing ingredients of fixed investment and goods-producing sectors have contributed to a more robust total GDP number.
More rapid pace of new orders, shipments and production lead to increased capital spending (CapEx) to increase capacity.
Europe is the other part of the world leading the global recovery and Germany is at the head of the table. Composite manufacturing and services momentum as measured by the PMI are strongly positive, like the US.
US and European unemployment rates of 4.2% and 3.6% are indicative of tight labor markets restricting the labor resources needed for the 3 to 5+% growth rates of past recoveries. Assimilating and training marginal citizens on welfare and expanding immigration is one option to extend the current labor pool, but more likely there will be an acceleration of capital expenditures for high tech plant and equipment to satisfy the pent-up demand. A private manufacturing operation we deal with has moved from record low backlogs to record high levels in the past year and struggles to find workers for entry-level or highly skilled positions to meet rising demand. This country is near full employment, yet moderate wage inflation indicates an economy far from overheating. Should annual GDP growth move to the 3%+ range, then we suspect wages will finally inflate at 3 to 4% rates and some overheating.
Consumer debt burdens and the ease of credit are the signs to watch for economic and stock market troubles ahead. Nominal debt levels may be hitting new records (normal in a growing economy), but the actual debt burdens felt by households remain near record lows due to low borrowing costs and our aging population. Every past expansion cycle has had several years of elevated consumer debt service expense prior to a recession. As we can see here low mortgage rates continue to provide substantial leverage for consumers who are less interested in new homes and pleasure boats as in past cycles and maintain near record low debt service burdens.
Every economic contraction has also been preceded by an inverted yield curve and tighter credit. The still positive yield curve and easy bank credit standards today indicate that economic overheating remains a more distant hill of concern while we continue to work our way out of the valley of slow growth and excess capacity.
The stock market may invite larger corrections after a 1st quarter 2018 peak as economic momentum and earnings growth slows, but this new up cycle starting in 2016 is in the middle innings of globally synchronous expansion with no signs yet of running too hot.