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The Economic & Business Outlook –––––––––––––––––––––––––

What Are the Opportunities & Risks Ahead?

Bernard Baumohl

Chief Global Economist

The Economic Outlook Group LLC

475 Wall Street

Princeton, New Jersey

(609) 529-1300

www.EconomicOutlookGroup.com

September 28, 2017

Brace yourself!

The world is about to change

economically & geopolitically!

HERE’S WHAT WE KNOW:

• U.S. economy remains fundamentally sound.

• Recent hurricanes to cut growth for 2017; expect rebound in 2018.

• Personal & corporate tax cuts are likely in 2018.

• Infrastructure & defense spending to increase.

• Regulatory rollbacks are underway.

• Incentives coming to repatriate foreign profits.

• Foreign economies finally growing again. U.S. economy to benefit.

The Economic Outlook Group


HERE’S WHAT WE DON’T KNOW!

• What kind of tax cuts will Congress pass & when?

• How much infrastructure spending will we see?

• Is a trade war looming?

• Will investigations and lawsuits against Trump

lead to a constitutional crisis and thwart the

entire economic agenda?

• Which major geopolitical risks are likely to erupt

–– and how will President Trump respond?

Scenario C

Scenario B

Scenario A (Trump’s tax & spending policy goal)

Annual GDP growth 3% - 4%

Economy slips into recession

• All out trade war

• A crippled presidency

• Major geopolitical eruption

• Fed raises interest rates too quickly

Growth 2% to 3%

• Congress passes more

modest fiscal plan.

• Geopolitical angst

Economic cycle peaked

Dec. 2007

2008 - 2009

recession

Recession ends

June 2009

The U.S. Business Cycle: Three potential paths ahead…


Trump era begins!

Scenario C 25%

Scenario B 60%

Scenario A (Trump’s tax & spending policy goal) 15% Annual GDP growth 3% - 4%

Economy slips into recession

• All out trade war

• A crippled presidency

• Major geopolitical eruption

• Fed raises interest rates too quickly

Growth 2% to 3%

• Congress passes more

modest fiscal plan.

• Geopolitical angst

Economic cycle peaked

Dec. 2007

2008 - 2009

recession

Recession ends

June 2009

The U.S. Business Cycle: Probable outcomes for the economy


Trump era begins!

Consumers will be the main engine of growth at least thru 2019

–––––––––––––––––––––––––––––––––––––––––––––––– The job market remains strong. Unemployment rate (4.4%) near 16 yr. low!

Firms actively seeking to fill 6 million positions each month!

Wages still rising faster than inflation; improves purchasing power.

Household wealth is record high! (Both nominal & inflation-adjusted dollars.)

Lower personal taxes in 2018 should help sustain consumer outlays.


Business impact thru mid-2018

Sectors to see greater sales growth: Sectors to face slower growth:

Autos Clothing

Home improvement Restaurants and bars

Appliances Sporting goods

Furnishings Leisure travel

Health care Gambling

Hurricanes Harvey and Irma will restructure household spending the next 6 months

• Both storms severely damaged homes, businesses and infrastructure

• States most affected were Texas, Florida, Alabama, Georgia, South Carolina

Destruction estimates:

Harvey: $175 billion

Irma: $60 billion

2017 -- GDP growth to slow in the 3rd and 4th quarters

3rd Q: From 2.4% to 1.8% = -0.6%

4th Q: From 2.6% to 2.3% = -0.3%

2018: Economy rebounds with rebuilding + auto purchases

1Q: From 2.1% to 2.6% = +0.5%

2Q: From 2.7% to 3.3% = + 0.6%

• Given the trend toward global warming, expect megastorms

to be more frequent.

• How costly those become will depend on amounts spent to

fortify new homes, commercial buildings and public infrastructure.

Overall impact from Hurricanes Harvey and Irma on GDP


ON WATCH: Broader factors that could dampen future spending!

1. After more than 8 consecutive years of shopping, consumer demand may be satiated. 2. Growing concern about the political crisis and legislative failures in Washington.

3. Major Demographic changes: Baby boomers retiring; Millennials not big spenders 4. Looming geopolitical shocks (North Korea, Middle East, China, terrorism).


US firms have long been absent when it comes to biz investments. RESULT: AGE OF AMERICA’S CAPITAL STOCK GETTING VERY OLD!

Age of private fixed capital: Average age is 22.4 years, oldest in 60 years. (Current-Cost Average Age as of yr. end 2015)

• Manufacturing facilities - 23.0 years old, surpassing the 1946 peak!

• Healthcare facilities (including hospitals) - 20.7 years, longest since 1949.

• Housing - 33.5 years, oldest since 1947.

• Lodging - 18.2 yrs, oldest in 53 years!

• Communications equipment - 6.0 years, oldest ever!

The Economic Outlook Group Source: Bureau of Economic Analysis,

Age of government fixed assets: Average. age is 24 years, oldest since 1925!

• Highways and streets - 28.4 years, oldest ever.

• National defense structures - 44.4 years old,

• Public transportation (airports and seaports) - 20.1 years

Source: Bureau of Economic Analysis The Economic Outlook Group

Chart: Business nonresidential fixed investment (equipment, structures, mining),

Quarterly % change, annualized

Firms are finally ramping up capital expenditures. But is it sustainable?

Demand for housing is rising: 1. Due to improving economy, jobs and post-hurricanes recovery

2. Household formation is also accelerating.

3. Mortgage rates remain near historical low levels.

4. Lenders relax on some mortgage requirements

5. But…there’s serious lack of inventory on new & existing homes.

Homebuilders still face numerous challenges 1. Difficulty finding skilled labor. Could be made much worse by immigration ban & hurricanes

2. Too many burdensome regulations. (Regs account for 25% of homebuilder costs.)

3. Lack of suitable and affordable land.

Source: U.S. Census The Economic Outlook Group

NEEDS UPDATE Friday 9/`1

Commercial RE construction has been in a rut! Residential construction edging higher.

Construction spending, in millions $, annualized Residential

Non-residential (CRE)

GOOD NEWS!

White House efforts to defund Brand USA in FY 2018 budget will likely fail.

(Brand USA is a government/private partnership program that

encourages foreign tourists to visit the United States.)

In the last four years, Brand USA’s promotions

brought 4.3 million MORE visitors to the US, who

spent an additional $13.6 billion and generated

nearly $4 billion in federal, state and local revenues.

--- Oxford Economics


The Economic Outlook Group Sources: US Energy Information Administration, The Economic Outlook Group

Sheikhs lose ground to Shale: Oil prices to hover in $35 to $50 range the next three years

–––––––––––––––––––––––

• OPEC/Non-OPEC accord to cut output has been extended. But compliance is eroding.

• New technology continues to reduce break-even point for U.S. shale producers.

• Shale oil mining equipment and know-how will gradually spread globally.

• Shift away from reliance on fossil fuel is inexorable! Will curb future demand for crude.

• U.S. oil exports has surged to a record 1.3 MBD, cutting into OPEC’s market share.


Consumer price index:

All items less food & energy: % Change YOY

Why is inflation slowing?

• Online & global competition has curbed pricing power

• Use of technology has reduced operating costs

• Modest wage increases

• Stable energy prices

• Fewer collective bargaining agreements

Very unusual! After 8 years of growth, inflation is falling!

Personal consumption expenditures price index:

All items less food & energy: % Change YOY

Federal Reserve’s target is 2%

Fed’s preferred inflation metric:

2.24

3.84

3.31

1.76

2.92

2.38

2.13

1.38

0.63

0.38

0.120.120.120.120.120.120.120.12

3.503.20

2.402.21

2.17

2.09

2.45

1.87

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Forecasts

The Economic Outlook Group Sources: Federal Reserve, The Economic Outlook Group

Yr. end fed funds rate %

Yr. end 10-yr US TR%

Interest rates to rise slowly---and will peak at historically low levels.

–––––––––––––––––––––––––––––––––––––––– Forecast: Long-term rates (10 yr. Treasury) to top out at 3.50% end of 2019

with fed funds rate to hit a neutral rate at 2.38%.

1.13


BUDGET AND DEBT CEILING: • Congress increases (or suspends) the debt ceiling beyond the next three months.

• After 3-month CR, FY 2018 federal budget eventually passes.

TAX CUTS IN 2018: C: Corporate P: Personal

• C: Cut statutory corporate tax from 35% to the current effective rate of 25% - 27%.

• C: Close many loopholes.

• C: Tax holiday of 10% rate will repatriate $1 trillion (of $2.6 T) in US profits stashed overseas.

• C: Implement “Territorial Tax System.” Profits earned outside the US will be tax free.

• C: Accelerated expensing of capital investments.

• P: Expect personal tax cuts. Higher standard deduction.

• P: Scale back on popular itemized deductions (mortgage, S&L taxes)

• P: “Pass through” incomes to be taxed lower for some businesses;

• P: Keep estate tax in place, though threshold may be raised.

INFRASTRUCTURE:

• Infrastructure spending to increase $350 billion over 10 yrs, not $1 trillion!

DEREGULATION:

• Focus will be on peeling back the regulatory burden on small and midsize firms.

Policy assumptions for 2017 & 2018

Forecast for U.S. GDP growth Economic activity to accelerate. Odds of recession thru 2019 are 25%

-4

-3

-2

-1

0

1

2

3

4

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Sources: US Bureau of Economic Analysis, The Economic Outlook Group The Economic Outlook Group

Real growth by year (%)

2.1 2.9 2.9 2.6

Recession

1.7 2.2 1.6 2.5

-2.8

-0.3 1.5

Average annual growth rate since WW II

2.5

Pre-storm forecast 2.3 2.6 2.3

Growth Leaders

India

China

Sub-Saharan Africa

In or Near Recession

Venezuela

South Africa

Brazil

Ecuador


Moderate Growth

Canada

U.S.

Australia

European Union

Japan

Mexico

NEEDS UPDATE WITH JAPAN

Needs update

So…what could possibly

go wrong?


ON WATCH: Greatest risks facing the U.S. Economy

Probability:

30% White House in full-blown political/legal crisis ---Trump gives up presidency

(1) Movement on the economic agenda grinds to a halt.

(2) Consumer spending and biz investments fades.

(3) VP assumes Presidency. Economy rebounds as path clears for tax reform.

70% President Trump finishes term amid continuing internal turmoil (1) White House remains preoccupied by investigations.

(2) Congress passes more modest tax cuts & infrastructure plans.

--------------------------------------------------------------------------

U.S. Policy Mistakes

15% (1) Federal Reserves lifts interest rates too quickly.

35% (2) President Trump imposes tariffs that triggers global protectionism.

--------------------------------------------------------------------------

45% Geopolitical eruptions

(1) Terrorism

(2) North Korea

(3) Saudi Arabia

(4) South China Sea

(5) Russia

(6) Cyber warfare


Employment by industry, nativity, and immigration status, pooled 2011 - 2012

Banning undocumented workers in the U.S. will hurt L&H industry:

• Nearly 10% of L&H employment consists of undocumented workers.

• Banning such workers will result in severe labor shortages and raise employment costs.

• Anger at US immigration policies is reducing international bookings to the US.

• US could lose more than $15 billion in tourism revenues on 2017 and 2018.

• Foreign travel to the U.S. is the No. 1 service export and No. 2. in total American exports.

Sources: National Bureau of Economic Research, Tourism Economics The Economic Outlook Group

Geopolitical pot is boiling furiously!


North Korea: War on the Korean Peninsula will trigger a global recession! IMMINENT THREAT:

• NK’s capability to launch a thermonuclear-armed ICBM at the U.S. homeland & allies is near.

• Neither UN sanctions nor China (nor Dennis Rodman) will stop NK’s nuclear program.

–––––––––––––––––– U.S. OPTIONS? Sanctions have failed! NK’s growth 2016 = 3.9%, a 17-year high!

1. Live with a nuclear NK. (Risk: U.S. adversaries and allies could view the U.S. a paper tiger.

NK can still engage in extortion. Will still sell nuclear info for hard cash.)

2. Utilize all available cyber tools and laser weapons to sabotage NK’s missiles in flight.

3. Shifts from “sanctions” to full-scale economic “warfare” against ALL who trade with NK.

4. Pre-emptive strike: “Eradicate” NK’s leadership and key nuclear sites. Risks all out war.


• Iran-supported Houthis are launching

missiles into S.A.

• AQ-AP

Iran’s Revolutionary Guards finance

terrorist attacks against Saudi oil

fields and Bahrain, home of

the US Navy’s 5th Fleet.

AQ and ISIS are sending

in suicide bombers.

Threat to Saudi Arabia and its monarchy to increase next 18 months!


Major Saudi oil and gas fields

Qatar

CHINA: Hybrid model of communism & capitalism has run its course!

Chinese leaders are deathly afraid of a

business cycle --- and will do anything! to avoid a recession.

• Economic growth has relied for years on rising government spending and easy loans.

• Grave misallocation of capital. (Result: stuck with empty office buildings, “zombie factories”)

• Nonperforming loans keep climbing. Capital fleeing the country.

• Chinese workers are losing confidence in Communist Party’s management of the economy.

• Economic reforms (shift away from industry/exports -- to consumption / services) are delayed.

• Economy is not on solid footing! FINANCIAL CRISIS MAY BE A MATTER OF TIME.

• CP seeks to distract from country’s economies woes by stoking nationalism.

The Economic Outlook Group Sources: National Bureau of Statistics of China; The Economic Outlook Group

SOUTH CHINA SEA: Crucial supply chain routes

–––––––––––––––––––––––––––––––––––––

• 55% of world’s merchant fleet tonnage pass here

• 32% of all oil shipments

• 65% of all natural gas shipments.

• Country dependence on energy supplies thru SCS:

South Korea 65%

Japan 57%

Taiwan 60%

China 80%


Result: “Russia doesn’t want war, it only wants the fruits of war”. Winston Churchill (1946)

• Russia has been in recession the last two years!

• Distribution of wealth most unequal in the world; Russian citizens increasingly fed up

• Country fails to diversify away from oil; Energy provides 70% of export revenues.

• Its population is shrinking, leaving an older demographic and fewer ethnic Russians.

• Russia is so corrupt, it is simply incapable of restructuring the economy!

Russia is punching way above its weight in the world: Fact: Its economy is smaller than Italy’s!


“Either you know you’ve been hacked --- or don’t yet realize it!”


CYBER attack allows for contact-free warfare!

(No direct military confrontation, yet does damage)

• Weapon of choice for Russia, China & North Korea.

For a fraction of the price of a MIG-29,

hackers can sabotage military systems, financial

markets, communication networks, power plants,

electrical grids, and influence elections.

––––––––––––––––––––––––––––––––––––

• Average time it takes for a U.S. firm to identify a breach = 201 days

• Average time it takes to contain the breach = 70 days

• Average cost of a single data breach = $4 million (29% increase since

2013)

Source: IBM Security - Data Breach Study 2016

1970 1985 1990 1995 2000 2005 2010 2015 1980 1975

0

20

40

60

80

Fatalities and Injuries From Terrorist Attacks Are Rising!

Total Fatalities Total Injuries

Thousands

Sources: Global Terrorism Database; The Economic Outlook Group The Economic Outlook Group

Terrorists favor soft targets - Shopping malls, theme parks, subways, airports, gambling venues have become preferred targets. These attacks deeply affect consumer psychology, dampen household spending and hurt business revenues.

1. Undertake “rigorous” stress tests.

Conduct “what if” scenarios: Introduce adverse hypothetical scenarios ––

events that can potentially disrupt business activity, limit access to credit, interrupt communications. and hamper your ability to satisfy clients.

2. Threat anticipation: Dedicate a risk management team to engage in geopolitical forecasting.

This team would monitor fast-changing geopolitical and economic events in regions where one’s assets, production facilities and supply chains are most at risk. The group should prepare scenarios and probabilities on how events may evolve.

3. Be proactive. Reduce your vulnerabilities. Focus on being agile.

Remember, clients expect reliable service from you…or they’ll walk!

Prepare in advance a governance plan that can be implemented quickly to mitigate

the harmful fallout from an external shock. Your firm’s reputation is at risk.

Every firm now faces event risk! Exogenous shocks to be more frequent and more consequential!


Bernard Baumohl

Chief Global economist

475 Wall Street

Princeton, New Jersey

(609) 529-1300

www.EconomicOutlookGroup.com

the economic & business outlook - s3.amazonaws.com · • neither un sanctions nor china (nor...

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