Economic Commentary January 2017

Posted on Tuesday, January 17, 2017

Economy Rebounds… But What'sup for 2017?

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By Mel Miller, CFA | Chief Economist

The first half of 2016 saw the economy "expand" only 1.1% - barely sufficient to describe it as an expansion. A tremendous third quarter followed, as the economy grew 3.2%, the largest quarterly expansion since 2014. The history of Q4 2016 is yet to be recorded, but here's what we know.

EC Graphic - Jobs Created FINALLet's start with jobs. The unemployment rate declined in 2016 from 5% to 4.6% in November. However, the monthly creation of new jobs has trended down since June. While still adding new jobs, the pace of creation is slowing.

While the unemployment rate is important, we must also consider the labor participation rate. The labor participation rate had started to recover starting in June of this year only to be followed by a decline in the fourth quarter. A declining labor participation rate means that individuals are either leaving the labor market because of retirement or because of frustration finding employment, or a combination of the two.
EC Graphic - Unemployment Rate FINALEither way, the lower labor participation rate was a key determinate behind the decline in the unemployment rate during the quarter to a level not seen since the start of the Great Recession.

Demographic studies point to further declines in the labor participation rate because of the aging labor force. Currently the number of individuals over 65 is approximately 21% and is projected to grow to 28% by 2020.

The trend should continue to 2040,according to the U.S. Census Bureau, until a high of 37% is reached. The aging population will have a major impact on the labor force for decades to come.

EC Graphic - U-6 Rate FINALA better measure of the health of the labor market is the U-6 unemployment rate which stands at 9.3% down from a high of 17.1% at the height of the economic downturn.

U-6 is considered the "true employment" rate. It includes total unemployed plus all persons working part-time out of necessity and those potential workers who have left the job market out of frustration as a percentage of the total potential labor force. While down from 17.1% it is still higher than the 7.9% rate recorded at the end of 2006.

Year-over-year, U.S. average hourly earnings showed no improvement over the second quarter level. But consumer confidence as measured by the Conference Board has trended higher since May and now points to an upturn in future consumer spending, which is generally good for the economy as a whole.

2017 Forecast

Let's review my 2016 prognostications for accuracy. I had originally forecast GDP growth of 1.8% to 2.2%. Following a tepid first half of the year, I lowered my forecast to 1.3% to 1.7% in my second quarter Economic Commentary.

Now I wish I had not lowered my forecast in July since the economy expanded 1.9% on an annualized basis for the first three quarters of 2016. Once the data is all collected and analyzed, the final GDP expansion for 2016 is likely to exceed the high end of my adjusted forecast of 1.7%.

The economic and market impacts of the Trump election victory have truly been a surprise-nearly as great a surprise as the election itself! The stock market gain of approximately 5.3% between when the polls closed on November 8th and the calendar year-end appears to be based on the belief that Trump's version of stimulus spending will drive the economy in 2017. However, it's difficult to see how the president-elect's economic policies will be able to deliver his promised 3% to 5% GDP growth next year.

I'm looking for GDP growth of 1.75% to 2.0% in 2017, very similar to 2016. If this forecast is correct, it's likely that the FOMC will only raise the Fed Funds rate one time during calendar year 2017.

EC Graphic - Value Of Dollar FINALI am surprised that so many economists are projecting more rapid growth in 2017, given the rising value of the U.S. dollar. Over 50% of S&P 500 profits derive from foreign sales and the rising dollar is hurting exports.

The strong dollar coupled with the trade rhetoric of president-elect Trump does not bode well for exports. The possibility of a trade war, and all the negative ramifications, cannot be overlooked.

Inflation is likely to trend higher in 2017 as the economy enters the eighth year of recovery from the Great Recession. Upward inflation pressure emanates from improving wages and the recent OPEC agreement designed to drive the cost of oil back up to $60 a barrel from a low of approximately $29 in early 2016.

EC Graphic - CPI FINALI would not be surprised if headline inflation exceeds core inflation in 2017 for the first time since August 2014. "Headline inflation" is the raw inflation figure as reported through the Consumer Price Index (CPI), while the measure of "core inflation" excludes certain items that are generally quite volatile.

I wish our president-elect well, for the sake of the economy. However, I believe there is a 20% probability of a recession in 2017.

I truly hope my forecast of 1.75% to 2.0% GDP growth is exceeded and a recession is avoided.

Happy New Year! 

Mel Miller, CFA is Chief Economist and a member of the First Affirmative Investment Committee. He monitors economic conditions and market movements, and keeps the firm and its network advisors current on economic issues.

NOTE: Indexes are not available for direct investment. Mention of a specific company or security is not a recommendation to buy or sell that security. Past performance is never a guarantee of future results.

Source of graphic data: Bloomberg