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As we begin another year, let’s look at the leading economic indicators that have influenced the wholesale trade in 2018 and will continue in 2019.
The business cycle is turning. Although we expect further expansion in the macroeconomy in 2019, the rate of growth will slow. Many macroeconomic indicators have already reached or are rapidly approaching peak growth rates for this cycle. U.S. real gross domestic product (GDP) was up 3 percent from the year-ago level during the third quarter of 2018. U.S. GDP will expand throughout 2019 but at a slowing pace.
While we do not expect a recession in the U.S. economy overall, activity in certain markets and industries will wane. The U.S. Industrial Production Index, our benchmark for domestic industrial activity, will contract by the second half of next year.
Identifying leading economic indicators that are unique to the wholesale distribution business will allow companies to look ahead at what may be coming in 2019. Consider the following economic indicators and what they may mean for your business during the coming years.
For the industry overall, the U.S. wholesale trade of hardware, plumbing, and heating equipment/supplies is expanding at an accelerating pace, up 5.6 percent from the year-ago level through the third quarter of 2018. The ITR Checking Point System suggests that a further rise in the wholesale trade rate of growth is likely in the near term.
However, macroeconomic indicators will exert downside pressure on wholesale trade during 2019 and into early 2020. Additionally, the rate of growth in U.S. nondefense capital goods new orders, a measure of business-to-business activity, has already peaked. New orders will contract by the second half of 2019. The U.S. Architecture Billings Index, which leads the wholesale trade by three quarters, has generally plateaued since late 2017, further suggesting headwinds for wholesale trade in 2019.
• Tax codes. Recent changes to the tax code may be providing a temporary boost to the U.S. economy. Lower taxes likely spurred activity during 2018, leading to a longer-than-expected rise in the U.S. industrial economy and business-to-business activity.
However, our analysis of historical data suggests that any stimulative effects from these tax cuts will not deliver longer-term economic growth. Most of the money freed up from lower corporate taxes is not being pumped into capital expenditures, but instead is being returned to shareholders or used to pay down debt. While these usages are beneficial in various other ways, they will not keep the economy growing at an accelerating rate in the long term.
• Tariffs and other trade issues. Tariffs and related trade tensions are also contributing to downside economic pressure. Global trade relations are increasingly important to all countries. The imposition of tariffs from the United States comes just as many of our trade partners are entering the back side of the business cycle.
The G7 Leading Indicator, a measure of expected future activity in the Group of Seven nations, is declining. G7 nations include the United States, Canada, the United Kingdom, France, Germany, Italy and Japan. Additionally, the rate of change in the World Industrial Production Index is declining from a second-quarter 2018 peak.
We expect world industrial production to expand at a slowing pace into mid-2020. However, the escalation of tariffs or other trade frictions could pose further downside risk for both the United States and our trading partners.
As with any economic policy, tariffs create relative winners and losers. ITR Economics does not take a position on partisan issues but we do examine the results so we know what to expect. Our concerns with tariffs are not political but center on the intended and unintended consequences that result from the tariff policy.
We reiterate our position that competition is generally good for economies; economics is not a zero-sum game. Tariffs and other trade barriers artificially skew incentives, leading to economic inefficiencies. These effects could potentially disrupt the supply chain. Retaliation from our trading partners also presents a downside risk for domestic producers. China, Canada, Mexico and certain European markets have already enacted reciprocal tariffs on U.S. goods, suggesting pressure on U.S. exports.
Finally, tariffs are nearly always inflationary, as they raise the price of imported goods to protect often higher-cost domestic production. Tariffs are contributing to increases in both the Producer Price Index (PPI) and the Consumer Price Index (CPI). A rise in the PPI will pressure business profitability and will require new strategies and tactics for passing rising prices on to customers. Meanwhile, higher consumer prices will squeeze consumer spending, making each paycheck worth relatively less as inflation rises.
• Consumer spending. The U.S. consumer ultimately underpins our economy, as well as the industry specifically. Warning signs suggest that a change in consumer activity is likely in 2019 and into 2020. U.S. personal savings as a percentage of disposable personal income is below the year-ago level, signaling that the U.S. consumer is in a relatively worse position to weather any economic shock. Gradually rising interest rates will place pressure on consumer finances.
Our proprietary ITR Consumer Activity Leading Indicator is declining mildly from a mid-2017 peak. The indicator, which is designed to suggest the possible course of business cycle movements three quarters in advance, suggests that the rate of growth in U.S. total retail sales will likely decline next year.
To be clear, we do not expect retail sales to decline. However, rising inflation will pressure consumer purchasing power. Anticipate higher prices, and not just volume, to support the rise in retail sales.
• Interest rates. Rising interest rates also will mean higher mortgage rates in 2019. U.S. single-unit housing starts are currently rising but will likely begin to decline by early 2019. The level of building has not recovered to pre-2008 levels, with almost 900,000 units started during the last 12 months compared to a high of more than 1.7 million units in 2006. We do not anticipate a Great Recession-style “cliff” forming due to overbuilding.
The outlook for multiunit housing starts is somewhat less favorable. Multiunit starts are modestly higher than the year-ago level. However, this will not be the case by early 2019 as demand for new apartment construction is waning. We expect a decline in multifamily building starts to persist into mid-2020.
More concerning for this industry is that U.S. existing home sales are contracting, down 1.8 percent during the 12 months through October. Existing home sales data has a 16-month lead time to the wholesale trade numbers of the plumbing and heating industry, suggesting downside pressure for the industry into early 2020.
In addition to higher mortgage rates, rising housing prices also are pressuring home affordability. While this trend bodes poorly for home purchasers, higher home prices are creating positive wealth effects for homeowners. Population movements are creating pockets of opportunity across the country, especially in Texas, Florida, much of the Mountain Region and the Pacific Northwest, where state populations are growing most rapidly. In comparison, the populations of West Virginia, Vermont and Illinois are declining. Look for opportunities to capitalize on these trends.
• Tight labor market. With a national unemployment rate of 3.5 percent, there are currently more job openings in the United States than there are job seekers. Labor shortages are creating uncertainty for businesses and fueling wage pressures. The U.S. hardware, plumbing and heating equipment/supplies wholesale industry employs more than 260,000 workers, a 2.0 percent increase from the year-ago level.
A tight labor market will persist into 2019, suggesting these business pressures will not abate. However, higher employment and rising wages are good news for the U.S. consumer. Consumer spending may pull back in 2019, but consumer health will be far from the precarious position of the prior decade. U.S. personal disposable income is still rising and retail sales will not contract.
Continued expansion in retail sales, combined with rising employment and the temporary boost from tax cuts, will support the U.S. economy into 2019. However, the preponderance of leading indicator evidence, along with further downside risk from trade policy, suggests business cycle decline next year and into 2020.
Although the macroeconomic picture for 2019 is somewhat dimmer than 2018, opportunities remain. We suggest using any slack over the coming year to identify inefficiencies in your business.
Target technology implementation and process improvements at the bottom of the business cycle when more time and capacity will be available. Automation will be increasingly important in the coming years. Then, use these improvements to prepare for the second half of 2020, when consumer headwinds ease and growth returns to the industrial economy.
Certain industries and markets will contract in late 2019. We suggest careful management of your cash reserves. Having dry powder on hand will enable you to take advantage of any depressed valuations during the trough of the cycle. Rising inflation will create consumer pressures in 2019 and may squeeze profitability. Develop strategies to counter these pressures.
Above all, track your company rates of change and examine your own leading indicator evidence. This analysis will enable you to glimpse what may be coming next in the macroeconomy and to stay ahead of the business cycle.
For more information, please visit www.itreconomics.com.
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