Thinking Ahead: Top Five Factors Challenging Future Economic Growth

The economy continues to struggle, with gross domestic product falling 1.4% in the first quarter, the first decline since the early days of the COVID-19 pandemic. However, the advance report wasn’t all dire, with consumer spending up 2.7% and business investment up 2.3%. Weakness in the report was driven by exports (-5.9%), government expenditures (-2.7%) and further strong growth in imports (+17.7%), which are counted against U.S. production.

In total, consumer and business spending represents just slightly more than 90% of gross domestic product, government spending represents 17% of production and our trade balance represents nearly an 8% loss. Compared to prior cycles, most historical recessions are driven by a weakened consumer base, which has not yet become an issue at this point.

While declines in government spending can be justified through a pullback in stimulus, the losses in exports are presumably tied to Russian sanctions as well as shutdowns in China, which are combining to slow goods leaving U.S. ports, amplifying supply chain bottlenecks and disrupting pricing.

With economic signals offering a murky outlook, here are a few metrics we’re watching closely:

• Declining real income: Inflation rose to 8.5% for the year ended March 2022, driving a drop in real income (excluding government transfer payments) and putting pressure on consumers’ purchasing power. Disposable incomes and savings rates are on the decline, and the combined result is that people are encouraged to tap into savings or incur debt to meet basic spending needs. Credit card spending is on the rise.
• Declining business investment: We’re also closely watching business investment as losses here could lead to an uptick in unemployment, which ultimately would solidify a recessionary environment. The Federal Reserve implemented a half-point rate hike to slow expansionary investment to address rising prices. Bond yields are rapidly increasing, with the 10-year Treasury note breaking 3% for the first time since 2018. We’re also watching the corporate bond market for any signs that businesses will have less working capital. If businesses pull back due to rising costs, an abrupt reversal in business spending could mean broad based hiring freezes and/or layoffs.
• Asset price corrections (a result of rising interest rates):
  • Corrections in housing and real estate: As interest rates continue to rise, fewer buyers will be found. The cost of homes for sale continues to increase rapidly as construction input costs rise alongside the cost to borrow. Also, many families are choosing to remain where they are since they can’t afford a comparable or better home. Our expectation is that rising interest rates will result in a buildup of inventories that will ultimately swing market conditions in favor of buyers. Further, commercial real estate capitalization “cap” rates are under pressure against higher interest rates and heightened risk free (and low risk) returns.
  • Corrections in stock markets: The stock market is also taking a hit with the S&P 500 on-track to post its worst month in April since March 2020. As investors watch the value of their holdings diminish and as businesses realize adjustments in valuations, conditions could prompt another slowdown in investment. Some investors may attempt to rebalance holdings elsewhere, but there is no clear safe place to go as asset price corrections and inflationary factors work in tandem.
• International COVID issues: As the U.S. transitions into more relaxed policy against COVID’s decelerating pandemic state, China continues to implement lockdowns in its two largest cities, Beijing and Shanghai, affecting nearly 180 million people and resulting in global economic losses. Many Chinese businesses are closed, and China’s unemployment was at a 21-month high as of March. If U.S. numbers do spike again, we could see more restrictions and lockdowns in certain areas, causing disruptions to local economies and ongoing bottlenecks in supply chains. Services spending is only just recently nearing pre-pandemic levels.
• War time policy: The war between Russia and Ukraine has no end in sight and the U.S. continues to commit billions in aid to Ukraine. At the same time Russia is extending threats against this support and has not signaled a willingness to negotiate. Attacks or cyberattacks on U.S. infrastructure (e.g., financial, utility, etc.) could cause swift and significant disruptions to the U.S. economy. Major economic losses could easily result in new policies that would likely exacerbate current imbalances in supply and demand. The sanctions in place today, or even expansion of new sanctions, will likely continue to weigh on future U.S. economic growth through 2022 as exports wane and imported goods continue to pour into the U.S.

While it’s still early in the cycle to know what will happen and when, we’re watching these and other factors carefully. If you have any questions about how this may impact your business, please reach out.