This Time is Different

September 12th, 2017

According to the National Bureau of Economic Research (NBER), which has been tracking U.S. economic cycles since 1854, the current business cycle — the duration from the conclusion of the last recession – is currently the longest on record.

Facts concerning U.S. economic expansions and subsequent recessions:

  • The United States has seen 33 business cycles since 1854, with each boom lasting an average of 38.7 months. In comparison, the current expansion is the longest on record at 121 months.
  • Business expansions are becoming increasingly lengthy. The average length of the last four expansions (since 1982) has been 101.5 months.
  • The period of the expansion has changed dramatically. Looking at the eight business expansions from the end of WWII to 1982, the average firm expansion lasted 44 months, or little under four years.

What happened to the business cycle in the United States? Why are periods of economic prosperity lasting significantly longer than they did in the previous four decades? Taking this topic a step further, do we notice indications in the present cycle that lead us to assume it will continue for some time, or is the current corporate expansion on the verge of collapsing? Looking at business cycles in addition to economic signals, as I will address later in this article, can help us predict the time of a slowing economy and impending recession.

What Has Changed

To understand why the United States' economic or business cycle has been considerably shorter in duration than in the past, we must first understand how the United States' economy has evolved and altered over the previous 50 years. Following the protracted, deep recession of the early 1980s, the business cycle began to extend.

To begin, we must comprehend why recessions occur. They occur as a result of either a substantial economic imbalance (too much or too little of one item or the other) or debt or credit imbalances. Second, we must accept that the US economy and what drives economic development have developed or changed over the previous several decades.

Prior to 1980, the United States' economy was structurally different from what it is today. Manufacturing production used to account for a substantially higher share of total economic output than it does now. Recessions were sometimes associated with "inventory cycles." That is just not the situation anymore. Just-in-time inventory systems have matured, assisting in the control of inventory levels. Manufacturing accounts for a smaller share of overall macroeconomic production than it did 40 years ago, because the service sector now accounts for a whopping 70% of GDP, according to The Economist.

Another element is the composition of today's workforce in comparison to 40 years ago. The workforce was formerly far more unionized than it is now. The decrease in private labor unionization has enhanced corporate flexibility, or the capacity to recruit and dismiss people more easily, which helps level the volatility of economic cycles.

Finally, the fundamental nature of company investments has evolved through time. According to The Economist, business investment is still at 14 percent of global GDP, which is in line with the long-term norm. However, firms are investing more in intellectual property (IP), which currently accounts for almost one-third of total corporate investment spending, up from about one-fifth in 1980. According to The Economist, investment in plant and property has declined as a proportion of total corporate investment spending over the previous 40 years. The rate of investment in intellectual property is steadier, or less volatile, than the rate of investment in plant and equipment. This tendency has resulted in reduced fluctuations in total corporate expenditure, which aids in reducing volatility in overall economic activity.

So, fundamentally, the US economy is today very different from what it was when I started in the investment sector in 1979. As a result, business cycles have gotten significantly longer, and recessions occur far less frequently than they did prior to 1980. The traditional four-year "boom" followed by a one-year "bust" has given way to eight years of modest growth followed by a one-year slump."

I don't think the time of the new business cycle will shift significantly, since I don't think the economy will revert to the days of 1950-1970, when manufacturing drove total company activity. The prolonged cycle has been with us for the previous four economic cycles and is unlikely to go anytime soon.

The Current Boom

According to the NBER, the current cycle has reached its 10-year anniversary. The cycle looks to be maturing, since the labor market, investment markets, and now Federal Reserve policies have all reached stages reminiscent of earlier mature "boom" periods of the business cycle.

As stated in last month's economic forecast, the Fed typically begins an interest rate lowering cycle before to the conclusion of a business cycle and the onset of a recession. The Federal Reserve has announced a decrease in the federal funds rate to 2.0 - 2.25 percent. Furthermore, the Fed's press release following its meeting implied that the process of quantitative tightening (QT), or shrinking the size of their balance sheet, had concluded. The Fed's activities show a goal to expand financial liquidity via the banking sector. Again, this is normal Fed action a year or two before past recessions.

What is the Fed's rationale for these actions? We have been emphasizing that, while overall economic growth has slowed in recent months, overall growth remains fair. Furthermore, inflation looks to be moderate. According to others, the Fed wants to purchase a "insurance policy" against further economic weakness. The Fed Funds rate was previously set at 2.5 percent. Is a firm going to make an investment at 2.2 – 2.25 percent if they weren't going to make one at 2.5 percent? I have my doubts. If the Fed cuts rates deliberately to decrease borrowing costs, I believe it will be disappointed.

Because the federal government is running massive deficits, the Fed did not decrease interest rates to compensate for government fiscal spending limits. I believe the Fed cut rates in part due to the value of the US currency and international economic activity.

Foreign economic growth has been quite low. Some feel that Germany, for example, is presently on the verge of a recession. Europe's and Japan's central banks want to start new rounds of monetary expansion. To do so without the Federal Reserve of the United States leading the way would almost certainly result in high levels of dollar strength relative to foreign currencies, which would damage our trade imbalance and reduce export growth rates from the United States. This, I believe, is one of the reasonable reasons why the Fed cut interest rates.

Finally, certain regions of the yield curve have inverted (the connection between short- and long-term interest rates). That is, short-term interest rates are currently greater than long-term interest rates. This is an exceptional occurrence that, in the past, has predicted the onset of a recession in the not-too-distant future.

Will the Fed continue to lower interest rates? According to the Wall Street Journal, Chairman Powell noted in his post-announcement that the rate cut was a "mid-cycle correction." Those hoping for confirmation that this was the first of a series of projected rate cuts were disappointed by the news. Having said that, depending on a variety of factors, I anticipate the Fed will cut interest rates again this year.

What May Be in Store

The final answer to the above-mentioned question – are we on the verge of a recession? – has to be "no." While the cycle looks to be mature, the bulk of indicators we depend on indicate that a recession is unlikely this year and maybe not next.

Don't get me wrong: there are still substantial economic hazards. Excesses used to be caused by recessions, such as housing collapses, oil price surges, or industrial contractions. We don't perceive such risks right now.

We do perceive economic hazards, such as:

  • As trade rules tighten their grip on China, globally interconnected enterprises may face pressure to modify production methods and sourcing quickly and dramatically. This atmosphere puts pressure on profit margins and increases economic uncertainty, which lowers company sentiment and investment growth.
  • According to Ned Davis Research (NDR) statistics, the business sector of the economy is extremely leveraged since debt as a proportion of national GDP is the greatest it has ever been.
  • According to certain reports, China's economic growth rate is fast slowing, and a cornered tiger is a dangerous one.
  • Nationalism is on the rise all across the world, not just in the United States, but also in Europe, India, and China.
  • As we grapple with the function of government, the United States remains politically divided. There are those on both sides of the extreme divide who don't regard the "middle route" as having any redeeming qualities. In many situations, the extreme approach is rarely the best one.

These elements all speak to a growing sense of insecurity. Economically, when people perceive insecurity and a higher-than-normal level of uncertainty, they tend to freeze and refrain from transacting, resulting in slower overall economic motion.

We have long predicted that total GDP growth will be weaker this year than it was last. As we reach the second half of the year, we remain confident in that assessment.

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