There is very little doubt that the U.S. economy narrowly avoided a recession this year. We faced numerous concerns that threatened economic growth, and the global outlook continued to worsen. Leading indicators were slumping, the economic benefits of the tax cuts had already realized, the yield curve inverted (a very ominous sign), and the global economy was sinking.
However, there has been a shocking reversal in both leading indicators and hard data. This has partly been spurred on by the Federal Reserve, but the cyclical nature of the global economy has shifted this year to one of expansion. This, of course, has helped to propel the stock market to all-time highs.
We will look at how bad the economic data looked this year and where we currently stand as we look forward to 2020.
U.S. Economy in 2019 – Near Miss Recession
If you recall, in December 2018, the markets reminded us that risk happens fast. The S&P 500 fell -15% in December alone, nearly -20% in Q4.
There was a legitimate fear that we were headed into a recession. However, while economic data was softening, GDP growth remained positive, and we did not slip into a recession.
It is important to remind everybody that the stock market is a forward-looking indicator, not necessarily a reliable leading indicator. This is an important distinction. In a free-market society, stocks are continually attempting to find their actual value through a mechanism called price discovery. This is the natural process that all stocks take when weighing all likely possibilities. It comes as no surprise that it is common for stocks to often overshoot its actual intrinsic value, both to the upside and downside.
Q4 2018 is an excellent example of the stock market overselling in the face of dour economic data. Yes, things looked bad at the time, but there was no data to suggest that the U.S. economy was contracting.
However, in early 2019, hard economic data continued to deteriorate.
- Leading indicators continued its slumping path, which began its decline in early 2018
- The economic benefits from the U.S. tax cuts in 2017 have already been realized
- The 10-2 yield curve inverted in August, something that hasn’t happened since 2007
- The global economy was contracting and slipping into a recession
And the list continued. In short, hard data was worsening to a point where fear of a recession was mounting, despite rising equity prices. Even worse was the fact that the global economy was already in a recession, and there were fears that this weakness would spread to the U.S.
An Economic Turnaround
In response to this threat, the Federal Reserve lowered interest rates three times this year.
This move, along with improving data, has undoubtedly helped to thrust U.S. and global equity prices higher.
Lower interest rates helped spur economic activity, including housing, which led to a sharp reversal in both leading indicators and hard economic data. The yield curve, at one point, had 70% of the term-spreads inverted. Shockingly, in October 2019, all yield curves have reverted and is now beginning to resemble a healthy upward-sloping curve.
Leading indicators are no longer showing a negative growth rate, but is now showing positive growth. Global economic data is showing signs of improvement, particularly within the European Union. Optimism is beginning to rise. Though, keep in mind that as conditions improve, this is only on a relative basis. U.S. GDP growth is expected to only expand by 1.8% in 2020 and global growth, only 2.6%.
While the state of the economy is always constantly shifting, it is clear that the momentum of the U.S. economy is one that is improving as we enter 2020. Let’s see if this continues as we enter an election year and one where we hope to finally resolve the U.S. China trade war.