Optimism Vs. Caution

By Scott J. Brown, Ph.D., Chief Economist, Raymond James Financial

It goes without saying that economic forecasting is not an exact science. As any statistician can tell you, there are two elements to a forecast: a point estimate, a prediction of where a certain variable, say GDP growth, will be in a year; and a range of uncertainty around that forecast. In economic forecasting, that range of uncertainty is large. Consumers, businesses and investors need to plan for the future, but we should recognize the risks. Economists have an old standby for the forecast narrative, “cautiously optimistic.” That sounds trite, but it’s a good description of the current outlook.

THEN
Prior to the election, a growing consensus had emerged that the U.S. and global economies had entered a new normal. Labor force growth has slowed as the population has aged. Barring a sharp rise in immigration or an unprecedented surge in productivity growth, overall economic growth will be slower than in recent decades. The economic outlook has appeared a bit brighter in recent months, but demographic constraints will still be binding, despite post-election optimism.

Job growth is expected to remain relatively strong, but should slow as the labor market tightens. Wage growth should pick up a bit, but the benefit of low gasoline prices is fading fast. The housing market has further room for improvement, but results are expected to vary across the income scale. Motor vehicle sales appear to be flattening.

Business fixed investment has been relatively soft in the past couple of years, but new orders for capital equipment began to turn up over the summer. The election resulted in a further boost for business optimism, strengthening capital goods orders and shipments into the new year. The global economy looks a little brighter.

AND NOW…
After the election, the stock market was lifted by expectations of a large infrastructure spending program, consumer and business tax cuts, and a rollback of regulation. However, infrastructure spending will likely be a tough sell in Washington, as the House is reluctant to increase spending. Tax cuts seem likely, but the process may be constrained and delayed, as lawmakers focus first on the repeal and replacement of the Affordable Care Act. Congress is expected to decrease regulations, but the Trump administration has the option of reducing enforcement of rules currently on the books. Yet, the regulatory burden may not have been the drag on growth that many believe. When Congress does get around to working on tax reform, a key goal will be to fix how foreign earning of U.S. firms are taxed.

The greatest risk to the outlook is U.S. global economic policy. U.S. manufacturing depends on the flow of parts and supplies from around the world. Arbitrary increases in tariffs on imports could kick off a trade war, disrupting supply chains and raising costs for U.S. consumers and businesses. Reforming taxes on the foreign earnings of U.S. firms is a priority, but there are huge risks if they get it wrong. Uncertainty could dampen business sentiment and curtail capital spending. Moreover, global capital flows are large and swift, and could be destabilizing. Foreign exchange in the U.S. dollar is $4 trillion per day, according to the Bank for International Settlements.

The U.S. economy is in good shape and investors should be optimistic, but they should also be aware of possible downside risks and be prepared.
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