After several years of slow-growing momentum in the U.S. economy, we have deemed 2015 the year of economic “lift-off.”
Lift-off is a term the Federal Reserve (Fed) typically uses to reference a transition from lower rates to a rising rate environment. For our forecast this year, however, this term can actually be applied broadly to the entire U.S. economy, signaling that meaningful improvement has arrived and will likely continue. So what will fuel this economic lift-off, and are there any variables to consider that may cause us to reconsider whether or not the economy is truly ready for launch?
Where we’ve been
The United States has been stuck in a below potential, moderately-growing economy since 2009. Most recently, we saw 2.2 percent real or inflation-adjusted GDP growth in 2013 – followed by a small improvement to 2.4 percent growth last year. So it shouldn’t come as a surprise that we anticipate additional improvement in 2015; but will this be a low-altitude lift-off near 2.7 percent or something more powerful, closer to 3.1 percent growth?
The economy is fueled by many factors, but there are a few that carry more weight than others. If you are familiar with UMB, you’ll note that we are driven by what the data tells us, not by what people say; the goal being to understand the difference between the signal and the noise.
This year we think the primary driver of growth will be the consumer. We think there will be three key variables to watch that should drive consumption and economic activity.
Jobs are one of the most telling and powerful variables in the economic formula. Most of the time, though, headline unemployment is the only data indicator used in reporting. We don’t think the value of that indicator is very significant. We prefer to hone in on actual job creation or payroll growth because it tells more of the story. The country has seen marked improvement in average monthly payroll growth since 2011, and with that, GDP has correlated nicely. In 2013, approximately 194,000 jobs were created per month (GDP at 2.2 percent); in 2014, the number was 246,000 (GDP at 2.4 percent) and we anticipate the labor market will stabilize or improve slightly, increasing to somewhere around 250,000 per month in 2015. Historically speaking, when the United States creates 3 million jobs a year, the economy grows faster than 3 percent.
One of our favorite signals to forecast payroll growth is availability of credit. Businesses need to know credit is available prior to expanding and hiring workers. Payroll growth and the willingness of banks to lend are highly correlated by as much as 85 percent. Today banks are open for business and lending standards are accommodative.
Consumer confidence has been improving and we think will continue to improve due to the labor market, stock and home prices, and of course lower energy costs. As we stated, the employment landscape is in excellent condition and on an upward trajectory. This adds to the formula for upward movement, along with a stock market that is up more than 200 percent over the last five years, home prices are up 30 percent over the last three years. As I have said before, when consumers feel good, they consume. This certainly seems to be the case.
Credit makes the world go ’round, and banks and credit are the lifeblood of the economy. Unfortunately over the past few years, millions of Americans were cut off from credit but today will once again have access to credit. From 2006 – 2009 nearly 5 million Americans, roughly the population of metropolitan Atlanta, defaulted on their mortgages. When you default on a loan, you are cut off from credit. Fast forward seven years after a default and that blemish has been expunged from your credit record, thus giving millions of Americans access to credit once again. With that, demand for bank loans has improved significantly. In 2007 loan demand was growing just shy of 10 percent, then dried up during the Great Recession, and resurfaced to nearly 8.0 percent in 2014. In other words, consumers and businesses are willing to borrow and consume yet again.
Houston we have a problem…or do we?
All indicators are telling us that things look positive, but as with any mission, we must explore possible hazards that could cause a ‘failure to launch.’ Let’s hone in on a few key variables:
Employment – Yes jobs have been created, but job quality has been in question for a few years. Now, though, we can see improvements. The national quit rate is on the rise, which tells us that employees are finding better paying employment.
Housing – Household formation data typically follows the economic cycle. When economic conditions are favorable, young people can find jobs. They move out of their parents’ homes and create their own household, increase consumption and create housing demand. Unfortunately, employment among the millennial generation (age 15-35) is incredibly low, indicating that many of them are unable to move out and create a household. Perhaps a more relevant group would be millennials aged 25-35, revealing that approximately 25 percent of them are not working, due to either unemployment or remaining in school. However, we feel confident that as the economy improves, this generation will have an easier time securing work, creating households of their own and thereby creating housing demand. Housing has not made a significant contribution to GDP over the last several years. This year we think housing starts will reach 1.2 million and add close to 0.50 percent to real GDP, which will be material.
Geopolitical – The U.S. economy operates on a global scale and we always have to be mindful of the geopolitical risks that exist. Most recently, we’ve had to a take a close look at potential action coming from the European Central Bank, as Europe has been on the brink of a recession for some time now. In addition, Russia has been put in a difficult situation with the price of oil down nearly 50 percent. Russia has a losing hand as a country where 68 percent of its exports come from oil and gas. While this proves problematic for some countries overseas, non-oil producing countries, such as Europe and Asia, will have a boost of stimulus through lower oil prices. Overall, we mark this as a risk, but not particularly threatening to our forecast in the United States since consumers will have an estimated additional $100 -$150 million of disposable income.
Policy Mistake – As previously mentioned, a Fed liftoff will occur when it begins to raise overnight rates up from the zero rate that’s been in place for several years. This could be called a “policy mistake” if the Fed were to begin pushing rates up before the economy is healthy enough to handle higher borrowing rates. We think that this is a very remote possibility, as inflation is still quite low and the Fed has little incentive to move rates up early or in a dramatic fashion. In fact, the interest rate liftoff that we think will begin later in the year will actually be good news, because it will signal that the central bank sees a US economy that is healthy enough to withstand more normalized rates. We think the Fed will move in a rational, measured manner that will not threaten the economic expansion.
Cleared for Lift-Off – Through careful consideration of what factors are fueling our economy and what could pose a risk to launch, we believe the U.S. economy is officially ready for lift-off.
Here’s what we anticipate for this year:
- GDP growth between 2.7 percent and 3.1 percent, supported by a robust labor market as businesses create new jobs
- Nearly 250,000 jobs created on average per month; this will drive unemployment down to 5.5 percent and many discouraged workers will return to the work force
- Another good year in domestic equities
- Corporate America will see 4.0 percent revenue growth and 6.0 percent earnings growth, which should lead to 10 percent total returns in the equity market
- Interest rates will be on the move this year, expecting both short-term and long-term rates to increase
In all, the above data and research proves that the economy is certainly prepared for a lift-off. Whether we will see GDP near 2.7 percent or slightly more significant at 3.1 percent, the year ahead is looking brighter than we have seen for quite some time.
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K.C. Mathews joined UMB in 2002. As executive vice president and chief investment officer, Mr. Mathews is responsible for the development, execution and oversight of UMB’s investment strategy. He is chairman of the Trust Investment, Asset Allocation and Trust Policy Committees. Mr. Mathews has more than 20 years of diverse experience in the investment industry. Prior to joining UMB, he served as vice president and manager of the portfolio management group at Bank of Oklahoma for nine years. Mr. Mathews earned a bachelor’s degree from the University of Minnesota and a master’s degree in business administration from the University of Notre Dame. Mr. Mathews attended the ABA National Trust School at Northwestern University and is a Chartered Financial Analyst and member of the CFA Institute. He is past president of the Kansas City CFA Society and a past president of the Oklahoma Society of Financial Analysts.
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