Taking a Slowdown Seriously

Recently, I’ve been working on the 2016 outlook, reviewing all of the usual data that we highlight monthly, as well as developing a series of other projections on wages, income, spending, corporate profits, and so forth. Although the consumer remains healthy, one of the things that has caught my eye has been a surprising deterioration in a number of business-related components of the economy, and it has me thinking about what this could mean in terms of an economic slowdown.

Low-growth sectors

Business investment, in particular, has been at the lower end of the growth range since 2011, and it appears poised to go even lower. Looking at the reasons for this, economic uncertainty has ticked up in the face of a potential Federal Reserve rate increase and actions by foreign central banks. Poor business sentiment in the industrial sector, as expressed by the Institute of Supply Management manufacturing survey—which recently dropped close to contractionary levels—may well drive that even lower, while the energy sector continues to downsize in the face of low prices.

The exports sector may also continue to subtract from growth. With the Fed poised to start raising rates and the European Central Bank doubling down on stimulus, the dollar is likely to stay at high enough levels to harm U.S. manufacturers and exporters.

These two components, of themselves, have limited ability to slow the economy, but the damage may be bleeding into the consumer sector as well. Consumer confidence, a key indicator I follow monthly, has pulled back sharply in both major surveys, while spending growth has slowed as well, probably in response.

A self-fulfilling prophecy?

It is, therefore, time to take the idea of a slowdown seriously. Although the fundamentals remain solid in many areas, it is quite possible that enough of a sentiment shift is occurring to make a slowdown a self-fulfilling prophecy. What could this mean for 2016?

Let’s define our terms here. At this point, a slowdown would mean growth (again) of around 2 percent, not a recession. It would mean reverting to the start/stop growth model of the past couple of years. What it would not mean is another 2008.

Doing the math

To figure out why, let’s do the math, using very rounded numbers. If we conclude that consumer spending will grow around 3 percent—consistent with the lowest levels of this recovery and very doable with wage income growth of 4 percent—that would give us economic growth of 2.1 percent, as consumption is about 70 percent of the economy. If we then assume that business investment is flat (a very pessimistic assumption), that government spending is flat (although we know it will, in fact, grow), and that net exports subtract 1 percent of growth, we still have positive growth. This is close to the worst-possible case under normal circumstances. Actual results will almost certainly be better than this scenario. The point is that even a real slowdown would still leave us in a substantially positive position.

Actual results may vary

At this point, I don’t believe we are headed for this scenario. Recent data suggests that the industrial area of the economy is stabilizing, while the service sector remains in healthy condition. The dollar has historically tended to drop after a rate rise, which would alleviate one headwind. Also, companies are coming to terms with low energy prices, and their performance should accordingly be better going forward. The assumptions above are very probably far too conservative, and actual results should be better.

Approaching normal

Nonetheless, a slowdown is worth taking seriously, if only to consider just how bad it could be. As noted above, as we approach normal, it looks like we might end up with only a normal slowdown—which, in the context of the past 10 years, is not that bad at all.