Economic Trends Affecting Business in 2018 and Beyond

In this second post of the series, we provide an overview of economic trends facing business owners in 2018 and beyond. This post will first focus on the U.S., followed by the global economy, and then global growth rates and industry trends.

U.S. Economic Trends

Buoyed by a surging stock market, the U.S. economy is experiencing one of its most expansive periods of the nine-year recovery, including 3.3% GDP growth in the third quarter. Kiplinger’s projections for 2018 include:

• GDP growth 2.6%
• Interest Rates 10 Year T-Notes 2.8% at the end of 2018
• Inflation 2.1%
• Crude oil $50-$55 per barrel in February

There is plenty to be optimistic about:

• The prospect of tax cuts has inspired confidence. The recent passing of the tax bill, now headed to “conference committee”, includes a 25% rate for most “pass-through entities.” 95% of corporations are pass-through entities.
• Consumer confidence is also high. After a rebound that lagged the recovery, new home sales exceeded 600,000 in 2017, and consumer spending will likely surpass $14 trillion in 2018.
• The global economy remains strong (see below).
• Inflation is in check at 2.2% through September.
• The renewal of U.S. manufacturing offers strong prospects. In the last year, over 156,000 manufacturing jobs were added in the U.S., and non-defense capital goods orders were up 7% this year.
• The stock market is raging. The Dow Jones Industrial surpassed 24,000 only a month after breaking through the 23,000 mark. The Dow and S&P have surged for eight successive months.
• 2017 results may have been impacted by natural disasters, given the costly effects of Irma and Harvey. Irma cost Florida $58 billion alone. Disaster recovery has become big business. Companies such as Cavalry and Belfor offered cleanup services to communities in the aftermath of Irma and Harvey.
• The infrastructure bill never came to fruition, and one must wonder if Trump will have enough political capital to get one passed in 2018. However, with U.S. roads and bridges at a breaking point, some Federal action is expected.
• There is significant backlog in construction, and the home improvement business is hot with 15% growth in 2017. Tax reform could provide an additional boost to the sector.

This enthusiasm must be tempered with the realization that the price-earnings ratio of the S&P is now higher than it was before the global financial meltdown in 2007, and the stock market is enjoying its second-longest bull run in history. As central banks start to draw back liquidity (stimulus), the global economy will soften at some point in the future. Should China’s economy stall- a real possibility given that its nonfinancial debt is more than 200% of GNP- the global economy could fall into recession, bringing the U.S. down with it.

Perhaps the biggest shackle to the U.S. economy has been stagnant wages. The middle class is finally getting relief, and jobs in production and transportation spiked 4% in Q3. A weakened dollar is also driving demand. While companies are reshoring manufacturing operations back to the U.S. of A., the jobs are not coming back with them. While it may be an inconvenient truth, automation (through smart robotics and the like) creates an output of eight to 10 times that of manual workers. The labor equivalent of manufacturing robots is about $2 per hour. But the real advantage for U.S.-based companies bringing their factories back to America is the ability to improve service levels by running just-in-time, and saving time on setup and tooling.

After a strong job expansion, new job creation will slow from 172,000 per month in 2017, to a projected 160,000 in 2018. Growth in manufacturing jobs in the last year has included increases in sectors such as machinery (+8.8%) and confectionary (+5.8%), and shifted away from high labor industries such as cut and sew apparel (-9.9%).

Incoming Federal Reserve Chairman Jerome Powell is seen as a centrist and collaboration builder. TheStreet has been looking for clues on Federal policy moving forward. Soon after he joined the Federal Reserve, he challenged Chairman Ben Bernanke on quantitative easing, the Fed’s response to the liquidity crisis. As a former banker (and not an economist by trade), it is expected that he will communicate in “plain terms”, providing more clarity to the market.

There is a softening of regulation. For example, the new appointee at Health and Human Services is expected to relax rules that provide guardrails for states and their insurance markets. However, the U.S. is expected to follow suit on tighter financial controls that have been instituted in Europe as a result of the financial crisis.

Commodity prices are expected to be higher in 2018 as a result of a weaker dollar and strong global demand.

The death of the American mall is well-chronicled, but a shocking 8,600 stores will close in 2017, illustrating the strength of ecommerce. There is, however, early evidence that online commerce will create more jobs than it will destroy.

Mergers and acquisitions remain strong. The FTC (Federal Trade Commission) has challenged DirecTV’s acquisition of Time Warner, stating concerns that the “vertical” merger would create too much market power. Forming the world’s largest entertainment company, it is feared that DirecTV could block or minimize competitors’ content on its platform.

Since CVS announced plans to purchase Aetna, vertical integration is having a larger impact on mergers and acquisitions. After a dramatic dip in 2016 and a return to 2015 levels in 2017, the IPO market is expected to spike to $71 billion in 2018, according to Baker McKenzie. They cite a stronger stock market, and the continued strength of the tech sector.

General Electric announced its plan to focus on only three sectors (power, aerospace and healthcare)- further evidence that it is difficult for conglomerates to manage complex, multi-sector businesses.

“We pay cash for flooded homes” signs are posted across flood-ravaged Houston. Wall Street has noticed, and institutional investors such as Bain Capital are already moving in on hard money lending and real estate acquisitions. Flood losses are estimated at over $57 billion.

Global Growth Trends

With the U.S. and Europe on strong footing, and Russia and Brazil breaking out of recession, prospects for the global economy have improved. Bloomberg Businessweek’s global growth projections include:

India 7.1%

China 6.8%

Spain 3.1%

Canada 3.0%

Russia 1.9%

France 1.7%

Brazil 0.5%

Germany 2.1%

UK 1.5%

Italy 1.5%

Japan 1.5%

Outside the U.S., Brexit is the biggest story on the world stage. Europe’s stock markets have not risen as fast as the U.S., as its economic cycle often lags ours. The UK’s exit from the EU in March of 2019 is putting pressure on all of Europe. Germany’s significant trade imbalance (it exports far more than it imports) has created tension there. A weakened Angela Merkel faces internal opposition for the first time, and the prospect of Brexit pushing Europe into recession is cause for concern.

A new version of the Trans-Pacific Partnership is forming without U.S. involvement. Our exclusion could impact U.S. companies’ exporting abilities.

China faces headwinds given its escalating wage rates, skyrocketing debt, currency fluctuations and reshoring. Any sudden action by China’s central bank (similar to devaluing its currency in 2015) could immediately impact global markets. Despite the attention on North Korea, South Korea has a strong export and consumer base.

As China cools, India is re-emerging as an economic force and important trading partner. India’s economy is expected to grow another 7% next year as the company replaces its currency, which has been subject to counterfeiting and fraud. India’s leading growth rate will be enhanced by lower interest rates now that inflation has normalized. Pakistan is also showing strong growth (projected at 5.5% in 2018), in part due to a unique trade pact with China.

In Japan, workers can finally expect higher wages in 2018. New monetary and fiscal reforms propel the country out of 20 years of deflationary pressure.

The long-awaited IPO of Saudi Aramco in 2018 is expected to be the highest-valued public offering on record. Saudi Crown Prince Mohammad bin Salman has unveiled his vision for 2030, which highlights plans to reduce the country’s dependence on oil. Among the hottest economies is Israel, which has more NASDAQ companies than any country outside North America. Iran is bouncing back from sanctions, and is expected to grow 5.7% next year.

Sub-Saharan Africa is growing faster than the world economy. Guinea and Ghana are growing 7% with the emergence of technology, currencies and political reforms.

Russia’s economy is highly dependent on oil prices, and the lackluster performance of the sector has been a constraint. Putin’s expected reelection in March will be a referendum on Western sanctions, which are further crippling the country (expected to grow only about 1%).

The Canadian economy grew faster in 2017 than in the last six years, buoyed by strong businesses and personal spending, as well as reforms aimed at boosting the middle class. However, a lackluster oil market and political fallout from Alberta pipelines provide resistance to long-term growth.

A July Presidential election in Mexico could be won by a left-leaning, antiestablishment candidate. With U.S.-Mexico relations already strained, free market conditions could erode there. Look for Trump to revisit the North American Free Trade Agreement early in the year.

Raúl Castro will retire in February 2018, and it is expected that the transition will lead to free market reforms.

Much of South America is swimming in debt. Argentina has a deficit balance of 5.6%, and Brazil is at 7.1%. But Venezuela, at 16% and facing inflation over 1,000%, is on the brink of default and is likely to be the next flashpoint on the world stage.

Global Industry Trends:

Automotive- There will be roughly 69 million vehicles sold worldwide, with recoveries in Europe, the Middle East and Africa. As emission standards have become more stringent around the world, the Trump administration is reviewing U.S. emission standards. Ridesharing, the prospect of autonomous vehicles, and dramatic increases in electronics are shaping the industry.

Aerospace and Defense- Global defense spending is expected to rise 4%. Expanded spending by the Trump Administration (the U.S. represents about a third of the world’s defense spending) and new spending in China and Germany will drive market expansion. The government is putting pressure on defense contractors to have great accountability. More agile weapons systems such as missiles and drones are proliferating. Boeing continues to face pressure from Airbus, and many U.S. aerospace suppliers have swelling backlogs. The industry braces for commercial space travel as Google, Virgin Galactic and SpaceX jockey for positions.

Energy- U.S. energy policy is shifting after the Administration’s exit from the Paris Agreement.

Arab cartels have unified around oil production capacity constraints that will run through March of 2018. Shale production ebbs and flows based on oil prices, keeping energy prices low during a time when renewable fuels are attaining popularity, and electric cars are quickly gaining acceptance.

Entertainment- Global entertainment will grow around 5%, reflecting the dramatic shift to online content as companies like YouTube, Amazon and Netflix duke it out. The U.S. government is placing restrictions on the AT&T acquisition of Time Warner, reflecting anti-trust concerns.

Financial Services- A decade after the onset of the financial crisis, world markets have normalized. Increasing interest rates offer banks opportunities for higher earnings. The biggest opportunities for financial sector firms are in Asia (including China and India), as well as stabilizing economies such as Russia.

Healthcare- Healthcare expenditures are not only rising in the U.S., but around the world, reflecting an aging population. There is renewed pressure to reduce costly prescription medicines, and for healthcare organizations to measure patient outcomes. Healthcare travel is proliferating. The proposed acquisition of Aetna by CVS, and rumors about Amazon’s entry into the pharmacy market, offer an industry shake-up.

Retail- In the U.S., Amazon’s acquisition of Whole Foods and Walmart’s alliance with Google are representative of a new world order. The Economist predicts global ecommerce will grow by a whopping 20% in 2018. 50% of ecommerce sales will be conducted in China, as merchant Alibaba is expected to grow by more than 40%.

Technology- As IoT (Internet of Things), augmented reality, virtual reality and the promise of 5G take shape, tech remains hot. Be on the lookout for our next post: Technology Trends in 2018 and Beyond.

Telecom- The average revenue per user is falling in every region of the world, as free apps such as messaging replace voice. The emergence of 5G will drive much of 2018’s activity.

While the global economy is stable, and the U.S. is the strongest it has been in some time, volatility has become the norm. From natural disasters to terrorism, from Brexit to high debt loads in Asia and South America, and to political uncertainty in the U.S., there are many flashpoints that could upset the apple cart at any moment.

 

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[i] Economy, Markets Rev Up, by Joshua Mitchell- The Wall Street Journal

[ii] Wall Street Journal/Vistage Small Business Monthly CEO Survey, October 2017

[iii] So-called “pass through” firms may soon get a big tax cut, The Economist

[iv] U.S. Bureau of the Census, via St. Louis Federal Reserve

[v] U.S. Economy Picks Up Steam, by Joshua Mitchell- The Wall Street Journal

[vi] Economy, Markets Rev Up, by Joshua Mitchell- The Wall Street Journal

[vii] Hurricane-ravaged U.S. cities hit by rising cleanup costs, by Rod Nickel- Reuters

[viii] The Kiplinger Letter, November 9, 2017

[ix] Is the bull market too good to last? by Philip Coggan- The Economist

[x] Great Again? The Economist

[xi] The Kiplinger Letter, November 17, 2017

[xii] The Industries of the Future, by Alec Ross

[xiii] American Industry Picks Up Stream, by Tangel and Zumbrun-The Wall Street Journal

[xiv] Reading Jerome Powell, Bloomberg Businessweek

[xv] The Kiplinger Letter, October 27, 2017

[xvi] What to Do with Dead Malls, by Higgins- The Wall Street Journal

[xvii] The 2018 Fortune Crystal Ball, Fortune

[xviii] The World This Week, The Economist

[xix] Flooded Homes, Big Money and Hard Choices, Bloomberg Businessweek

[xx] The World in 2018, The Economist

[xxi] Good-ish times for the Global Economy, The Economist

[xxii] GNP Growth for Large Economies, Bloomberg Businessweek

[xxiii] Nations to Watch in 2018, Bloomberg Businessweek

[xxiv] The Kiplinger Letter, November 22, 2017

[xxv] The Kiplinger Letter, November 22, 2017

[xxvi] Saudi Arabia taps the breaks- The World in 2018, The Economist

[xxvii] The World in 2018, The Economist

[xxviii] The World in 2018, The Economist

[xxix] The World in 2018, The Economist

[xxx] 2017 Telecommunications Trends, by el-Darwiche, Péladeau, Rupp and Groene- Strategy&