Looking Ahead: 2019

by Mark Bern, CFA

First, let me reiterate that I expect the remainder of 2018 to be stronger than most financial pundits and economists do.  OECD (Organization for Economic Co-operation and Development), an organization of mostly developed countries, projects that GDP will grow at 2.78% for all of 2018.  After the results of quarters 1 & 2, that would require the third and fourth quarter growth to drop to a dismal average of 2.41%.  The folks at The Kiplinger Letter are projecting 2.9% for the full year; not much better.  The Conference Board, which is much more enthusiastic about our nation’s growth potential, forecasts a 3.3% GDP growth for the second half of the year bringing the full year estimate to about 3.2%.  Forecasts are all over the board but most (that I have seen) expect growth below 3%.

While I hope the Conference Board is correct, I am not quite as enthusiastic.  My expectation is for growth to drop down to a still respectable 2.8% in quarter three and then bounce back up to 3.1% in quarter four.  That would result in a full year GDP growth rate of 3.1%, not outlandish but still a bit more optimistic than most.  Why is this important?

The gap between my expectations and most others increases dramatically for 2019.  I have good reason to assume that I am using information that is not included in the forecasts of others (at least not yet).  They will catch up eventually but I expect them to remain gloomier than I am.

Well, I have to admit that I may have cheated a little.  I used more recently available data that was not available when most other made their respective calculations.  To be specific, I included the newly adjusted U.S. savings rate calculated and just released by the Bureau of Economic Analysis (BEA) within the Department of Commerce.  Instead of a savings rate (as previously misreported) about 3.3%, it is 7.2%. 

“Bolstering the hypothesis is the fact that the revised saving rate shows virtually no decline since 2013, even though unemployment has fallen by roughly half and home and stock prices have risen sharply.

“This contradicts “what was thought to be one of the more reliable regularities in macroeconomics,” the so-called wealth effect, said J.P. Morgan Chief U.S. Economist Michael Feroli. The theory holds that consumption rises and saving falls as household wealth climbs.” – Wall Street Journal

The revisions to income and spending means that savings increased.  Since credit levels are also tracked and did not change apparently, it is just how the math works out.  This is really good news for our economy.  It means that households and consumers are in much better shape than previously thought.  It also means that people have not forgotten the beatings taken during the last two recessions and, thus, have prepared far better for the next one.  This translates into a potentially more resilient economy going forward, better able to withstand the shocks of a recession and to rebound.  That is a trait that was sorely lacking in 2007 and stands in stark contrast from 2005, when the savings rate was near an all-time low around 2.5%.

It should mean that the current bull market (which turned into the longest on record today) still has additional potential.  It has been lamented broadly that the consumer in America is tapped out.  Surprise!  It just isn’t so.  Reality is much rosier than we thought.

What does 2019 Look Like?

If you listen to most economists and financial talking heads you are likely to hear that GDP growth is peaking in 2018 and should fall off gradually in 2019 to end with a fourth quarter rate of a more pedestrian 2.5%, or less.  For the full year, most are predicting between 2.6% and 2.9%.  Even the more optimistic folks at The Conference Board are expecting 2.9%.  But beyond 2019 it seems everyone expects GDP growth to fall further and be closer to 2% than 3%.  I think that is too pessimistic, unless the White House and Congress changes hands.  I may be wrong, but I believe that continued business-friendly leadership will prevail in Washington, D.C. and that further improvements to our economic fundamentals are likely.  This isn’t an endorsement of one political party over the other; I don’t really trust either.  It is merely an opinion of what I expect to happen, contrary to most prognosticators of electoral outcomes. 

Inflation is likely to hold steady at around 2.5% for 2019, same as in 2018.

Interest rates will rise as the Fed continues to increase short-term rates and the cost of borrowing will follow suit with home mortgage rate rising to about 5%.

Corporate profits will continue to grow strongly, up as much as 10% over 2018.  This will be driven primarily by slightly higher business investment and rising wages as businesses both invest in more efficient automation while also competing to attract and retain skilled employees.

Cost increases for pharmaceutical drugs should slow down significantly to about 5% in 2019 after having risen by double digits in recent years.

The price of crude oil could continue to rise into 2019 with gasoline at the pump increasing to near $3.00 per gallon compared to the current national average of $2.73. 

The impact of tariffs will be negligible in the U.S. as negotiations are likely to continue throughout the year with China and other trading partners.  I cannot help but suspect that China will continue to negotiate, but at a slow pace, hoping to hold off on any substantive agreement until after the election in 2020.

There isn’t anything revolutionary in my predictions.  I merely see stronger growth because of higher wage growth (leading to better consumption numbers), rising business revenues, improving productivity due to investment in efficiencies, an improving workforce participation rate, decreasing regulatory costs, lower taxes, expanding corporate cash flows and higher corporate profitability.  It seems that most other forecasts are discounting many of these developments.