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John Dessauer’s market review and update as of Wednesday February 20, 2019

            According to some recent government data the U.S. economy could be slowing down. For example, the Commerce Department says retail sales dropped slightly in December. However, some economists point out that Amazon reported a strong December and so did several other major retailers. They wonder if the government shutdown is distorting the economic data because so many government bean counters were not working. Of course, time will tell. But meanwhile I found the following article to be quite helpful.

“Are we looking at a U.S. recession or not?

Nearly every week, economic news tells us one short-term story about America, while the political news suggests something different, and darker, is coming soon. A jobs report might say things are great, at the same time a government shutdown threatens to disrupt growth — and the Trump administration faces off with Congress over the Mexican border wall and China over trade.

Naturally, this makes markets wobble — has since December. On Monday, Nobel Prize-winning economist Paul Krugman stirred things up a little further by saying there’s better than a 50/50 chance of a world recession this year or early next. What should you, ordinary investor, do about it?

Bet on America — or so says a report from Bank of America Merrill Lynch that caught my eye, equally for its headline (“Why We’re Bullish on America,”) and for the simplicity and quality of its argument.

Merrill’s North American chief economist Ethan Harris puts it plainly: Recessions happen for specific reasons and none of those reasons is on the horizon. Even if only 42% of Americans approve of the president and most of the rest think he’s a jerk and a chump whose bloviations add little but uncertainty.

“Business cycles don’t die of old age — they die of excesses,” Harris wrote. “The current cycle is likely to continue setting records, as none of [the usual] warning signs are flashing.”

Specifically, Harris says, recessions happen for one of three reasons. Ask yourself whether they’re happening in America now.

First, they happen when central banks are fighting inflation and overshoot the mark in tightening interest rates. This is how we got into the double-dip recessions in the late 1970s and early 1980s, for example.

But that’s not happening. We just saw the Federal Reserve back down from money-tightening, declining to raise interest rates and signaling that it may be done for a long time. On top of that, the central bank said it would be flexible about letting its bond portfolio shrink as the bonds it holds mature, which also would have the effect of slowly pulling money out of the economy. So flexible, in fact, that it might resume buying up bonds if needed.

So the Fed won’t wreck the U.S. expansion - which will be the longest ever by fall - by going nuts to fight inflation. And they shouldn’t, because there is none. Not only do the major inflation measures remain below 2%, but the Fed’s 2% target rate is “symmetrical” — meaning central bankers will tolerate some inflation above 2% because it has been below the target every year since 2011.

Second, the administration and China both seem to be de-escalating the trade-war talk. Harris said. After watching Trump go for face-saving deals with Mexico, Canada, Europe and Korea that changed little, the odds say he’ll do the same with China.

“Trump’s hawkish advisers are essentially playing bad cop,” Harris wrote, “making very strong demands to achieve the best compromise.”

Third, and most important, there just aren’t any big bubbles in the economy right now. The surest sign of recessions for decades has been a big investment boom that got overdone — housing the last time, technology stocks by 2000, and commercial real estate heading into 1990.

The bubble bursts, people and companies who were flush are suddenly strapped, and a cycle of cutting back ends in a recession — a bad one in 2008, pretty mild each of the other times, with unemployment peaking at 6.3% in 2003 and 7.8% in 1992.

Certainly, there’s no bubble in oil, the commodity whose skyrocketing price wrought steady havoc on the U.S. economy from 1973 until 1983, sparking three recessions amid inflation those downturns finally broke. I paid $1.82 a gallon for gasoline in Texas two weeks ago, and crude’s CLH9, +2.25%  at $52 a barrel — both about half of what we saw a few years back. With fracking technology still improving, the outlook is for still-cheaper energy.

In stocks, there’s only mild froth, with the S&P 500 SPX, +1.15%   trading at 16 times earnings. In bonds, low interest rates mean easy payment burdens, though corporate debt is high. For consumers, the story’s the same — student loan debt makes total indebtedness sound scary, but the percentage of incomes devoted to debt service is near the recent all-time low.

Krugman’s argument is that the next recession may have not one or two causes, but a multitude of small ones — if that’s true, it would be the first such U.S. downturn in decades. It’s easy to see what those could be — trade policy, economic weakness in China or Europe, a fast-rising budget deficit and the expected drop in 2019 earnings growth to about 5% from a 20%-plus clip for part of 2018.

As Krugman notes, it’s hard to see recessions coming, easy to predict them when they are not, and everybody’s track record is poor.

It’s far from obvious — scorn for the president notwithstanding, and I’m not far behind Krugman on that score even as the good professor sets a high bar — that a collection of small economic problems can actually cause a U.S. recession.

Let alone that it will derail this expansion, which has been as durable as it has often been uninspiring.”

Tim Mullaney, Economics correspondent for USA Today

I will have the next market review and update for you one week from today on Wednesday, February 27, 2019.

All the best,

John Dessauer

© February 2019