Employment is the key to the strength of the economy

John Gonner PHOTO CREDIT: Contributed

The economic recovery we are enjoying began in June 2009 after the severe recession associated with the financial crisis ended.

As of January, we are 127 months into this expansion, which doesn’t show signs of ending any time soon. This is the longest lasting economic expansion in our history.

While the economic expansion has reached old age in terms of months of duration, it is middle-aged in terms of economic growth created. Four of the past 10 expansions created more growth than the current expansion.

The 1960s and 1990s expansions created about twice the growth. When this economy does eventually move from an expansion to a recession, there will be a sell-off in stocks. Therefore, from an investment perspective, we must look for signs that this record-length recovery might be ending.

There are many indicators used to gauge the health of the economy. Since about 70% of the U.S. economy is comprised of consumer spending, the health of the consumer is a good place to start. People are more likely to continue/increase spending if they have a job, feel confident that they won’t lose that job (or that they could get another job if they wanted) and their wages are going up.

The jobs picture has been good for several years and it continues to be very good. Weekly jobless claims have been at historical lows, and the unemployment rate is the best that it has been in 50 years at just 3.5%. Economists expect unemployment to go even lower during the next several months. Wages have been growing at a good rate, too. As a result, household net worth is at an all-time high.

Another important indicator to evaluate is interest rates and the Federal Reserve. Each of the last seven recessions going back to the 1960s has been preceded by an inverted yield curve, which is when interest rates on longer maturity bonds are lower than interest rates on shorter maturity bonds.

Usually, this is the result of the Federal Reserve raising short-term interest rates too much. We briefly experienced an inverted yield curve just before Labor Day when the yield on the 10-year treasury note was lower than the yield on the 2-year note for eight days. This heightened concerns that a recession would begin sometime in 2020.

Inflation has been tame and below the Fed’s target for most of the past 10 years, allowing them to be accommodating for longer. The Federal Reserve lowered short-term interest rates in a mid-cycle adjustment in July, September and October. The yield curve, while relatively flat, has since returned to a more normal, upward-sloping, shape. With the presidential election next year, the Fed will be reluctant to make any further changes to monetary policy until afterward.

Trade negotiations with China have been weighing on economic activity for more than a year. This caused the manufacturing side of the economy to contract significantly in the second half of last year.

A “Phase-One” deal does not alleviate the larger trade issues between the U.S. and China. Although it has gotten less publicity, the U.S. also is in a difficult trade battle with Europe primarily over tariffs on automobiles. European autos sold in the U.S. are subject to a 2.5% tariff while U.S. autos sold in Europe have a 10% tariff on them.

Concerns about trade will likely be a factor weighing on the markets for several years. When progress is made on this front, it will be positive for the economy. When trade tensions are escalating, it will be a negative.

While trade has negatively impacted the manufacturing side of the economy, the services side has performed much better. The Institute of Supply Management services activity index has remained solidly in expansion territory and the Markit U.S. services survey has been up and in positive territory. For our economy, services outweigh manufacturing 2:1.

The excellent heath of the consumer and strength in the services side of the economy should be able to overcome the uncertainty around trade, the upcoming presidential election and slow global growth, and keep the U.S. economy growing.

Although every recession in the last 50 years has been preceded by an inverted yield curve, not all instances of an inverted yield curve were followed by a recession. I believe the inverted curve we saw in August will be one of those not followed by a recession.

One thing to monitor closely is the weekly jobless claims, which come out every Thursday morning. If claims move up significantly for a few weeks in a row, it could be an early warning sign of trouble ahead for the economy and the stock market.