What’s Going On With the Economy?
Baird Investment Strategist Willie Delwiche adds context around today’s headlines.
Many investors will equate the performance of the stock market with that of the economy, thinking that if the stock market goes up, the economy must be improving accordingly. While it’s true that, over the long term, the two tend to move in the same direction, there are a lot of things that can impact the country’s financial growth outside of Wall Street. Let’s take a closer look at some of the more prominent political and financial headlines moving the U.S. economy.
A tariff is a tax on goods made outside the United States as they enter the country. While tariffs are primarily used to raise revenues and exert economic leverage, they have the added impact of protecting domestic goods by making their foreign counterparts more expensive.
Why People Are Talking About Them Now
President Trump has levied several tariffs since taking office in 2016, on goods ranging from solar panels to washing machines. (In June 2018, in response to the United States issuing tariffs on European steel and aluminum, the European Union issued their own tariffs on many U.S. goods like bourbon and t-shirts. These tit-for-tat acts of economic retaliation make up what’s commonly known as a trade war.) Over the past year, the United States has imposed more than $360 billion in tariffs on China, which has responded by levying $110 billion in tariffs on American goods. While both countries have threatened to impose additional tariffs in the coming months, if they were to make progress on a comprehensive trade deal, they could ease or even eliminate these tariffs.
How Tariffs Could Impact Your Finances
While tariffs are meant to influence foreign policy, the tax itself is paid by domestic consumers – for example, when in May the U.S. imposed tariffs on all goods from Mexico, that tax was paid by those U.S. consumers who bought those goods. Moreover, companies that are losing income due to the imposition of a tariff (such as Mexican avocado producers) might decide to try to make up that lost income by raising prices.
Tariffs can also have an outsized impact on businesses. When China imposed a 25% tariff on U.S. soy in July 2018, farmers in Illinois – where soil is well-suited for legumes like soy – saw the Chinese demand for their soy evaporate overnight, resulting in a 30% drop in price. Worse, it opened the door for other soy-producing countries like Brazil to establish a stronger foothold in the world’s soy market.
Advice From Willie
“It’s not so much today’s foreign policy decisions as it is the uncertainty of what could happen tomorrow. What’s the landscape going to be next week, next month or next quarter? If you’re a business owner, it’s hard to commit to a course of action today when tomorrow could be entirely different.”
Interest rates indicate how much it costs to borrow money, expressed as a percentage of however much you’re borrowing. In the U.S., the Federal Reserve sets the interest rate at which banks can borrow money, known as the Fed Funds rate.
When the Fed increases or decreases the Fed Funds rate, it has a ripple effect across the entire economy, affecting mortgage rates, business loans, bond yields, credit card interest, savings rates and more. A Fed decision to lower interest rates often spurs consumer spending, while higher rates tend to inhibit spending.
Why People Are Talking About Them Now
For the first time since 2008, the Fed cut interest rates in July and then again in September, moves many economists have interpreted as signaling a weakening economy – an economy that might require an artificial boost in consumer spending. As a recent example, in response to the dot-com recession of 2001–2002, the Fed cut rates to 1.25%, which stimulated consumer spending and greatly sped up the recovery. While additional interest rate cuts could still boost spending, they could also boost speculation as to the country’s economic health.
How Interest Rates Could Impact Your Finances
Lower interest rates are often seen as a boon for businesses: When it becomes cheaper for consumers to borrow money, be it for a house, business equipment or personal spending on a credit card, they’re more likely to buy goods and services. That increased economic activity stimulates company earnings, which also appeals to stock market investors. Lower interest rates also mean lower yields on new bonds, though, which can make it harder for bond investors seeking returns.
Advice From Willie
"While lower interest rates can provide a short-term lift and be a useful tool in smoothing out periods of volatility, higher rates can indicate economic strength and boost consumer confidence."
Inflation measures how much the cost of goods and services changes over time. If a cup of coffee cost a quarter 40 years ago and $1.50 today, we’d mainly attribute the difference in price to inflation (“a dollar doesn’t buy as much as it used to”). It’s commonly measured by the Producer Price Index and Consumer Price Index, which track how much it costs to produce and buy commonly purchased goods.
Too little inflation suggests there’s low demand for domestic goods and services, which can slow economic growth and potentially signal a recession, as it did in 2008. Too much inflation can also cause the economy to falter – the combination of rising inflation and falling employment numbers (known as stagflation) is what caused much of the economic hardship in the 1970s. A healthy economy is often called a Goldilocks economy because inflation is just right – not too hot, not too cold.
Why People Are Talking About It Now
In their September 2019 meeting notes, the Federal Reserve decided to lower interest rates due to “muted inflation pressures.” (It fell from 1.8% to 1.7% in August, slightly below its 2012 target inflation rate of 2%.) If – and how much – inflation continues to decline or picks back up will be a major consideration in the Fed’s future interest rate guidance. This was and continues to be a major concern with the economic recovery over the past decade – how to walk the fine line between keeping interest rates low despite inflation ticking up.
How Inflation Could Impact Your Finances
While inflation makes goods more expensive to buy, it also increases the value of goods you already own. (You might not like that your coffee costs twice as much as it did 30 years ago, but if your house similarly doubled in value, you might not mind so much.) Businesses often make capital expenditures in times of increasing inflation, and many investors choose to invest more heavily in the stock market.
Advice From Willie
"Inflation normally picks up as recoveries move along. While to be sure there is danger in letting inflation run too high, higher inflation rates suggest that the economy is experiencing a healthy, organic recovery."
The National Bureau of Economic Research defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months.” Most market-watchers use a general definition of two consecutive quarters of economic contraction, based on changes in GDP, household income, employment, industrial productivity and retail sales. (A recession is not to be confused with a depression, which is an extreme economic downturn that lasts three or more years and leads to a 10% or greater decline in GDP.)
Why People Are Talking About It NowWe’ve recently seen several financial occurrences that have commonly – but not inevitably – preceded a recession, including:
- An inverted yield curve, in which short-term bonds carried a higher yield than long-term bonds
- Slowing GDP growth
- Significantly reduced earnings estimates
- Ten-year lows in manufacturing growth, partly a result of current trade wars
However, these signals, while concerning, are not always reliable. For example, as was pointed out in Baird’s Fixed Income midyear outlook and elsewhere, while recessions are often preceded by flattened yield curves, not every flattened yield curve leads to a recession. That’s why we stay alert to multiple trends and indicators, rather than just one or two.
How a Recession Could Impact Your Finances
Recessions often provide a real-life stress test for your investment strategy. It’s easy to say you have a high tolerance for risk when the economy is showing even a moderate amount of growth. Only when push comes to shove in the form of a downturn do many investors realize that their finances aren’t as recession-proof as they thought – leaving them trying to rebalance their portfolios at the worst possible time. Avoiding complacency and truly understanding your real-life tolerance for risk is the key.
Advice From Willie
"No one can predict the future, but what we can do is look at the weight of the evidence and get a sense of what amount of risk is appropriate given the overall economic conditions. When you can manage risk proactively and thoughtfully, it allows you to weather turbulence with as little disruption as possible."
Reasons for Optimism
Understanding the interplay of elements that make up the economy can be a challenge, and it’s very common for those in the financial media to latch on to one concept and make assumptions about the rest – especially if that one indicator can be sensationalized for maximum viewership. The truth is, while tariffs and inverted yield curves are important indicators that bear close monitoring, there’s a lot of positive momentum in the economy right now that’s not getting much attention. For example:
- Real median household income in the United States has increased every year since 2014 and is currently at an all-time high.
- Less than 10% of U.S. household disposable personal income is used to service debt, a low not seen in 40 years. According to FICO, the national average credit score has been steadily increasing since 2009 and hit an all-time high of 706 in September.
- Labor productivity in the private sector has never been higher.
- Unemployment is at a 50-year low, and even the under-employment rate is at lows not seen since 2001.
When it comes to the economy and your investments, it’s critical to not act hastily – take a moment to make sure you’re getting the complete picture before you act. Your Baird Financial Advisor can sit with you and discuss the impact these macroeconomic events can have on your specific investments and plans.
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