Vanguard’s chief economist, Joseph “Joe” Davis, told a packed house Wednesday morning that the U.S. economy remains healthy and that the firm is sticking with its prediction for only one more interest-rate hike by the Federal Reserve in 2019.
“We had previously expected two rate hikes in 2019, but we’ve reduced that to one hike,” he said after his remarks to the Philadelphia Chamber of Commerce, where attendees breakfasted at the Bellevue Hotel and heard from business leaders on the region’s economic outlook.
He compared the U.S. economy to Philly’s hometown movie-hero boxer, Rocky.
“There are legitimate concerns for the economic outlook," he said. "But the theme for 2019. in my mind. is a boxing analogy: down but not out. Even if Rocky wins the fight, he takes a beating. In shorthand, that’s the outlook for the United States and the global economy. Some material risks are outside our borders.”
Vanguard’s model predicts a less than 50 percent chance of a recession in 2019, he added.
“There are reasons why we don’t see a recession,” he explained, including a strong labor market, a U.S. economy that is not yet overheating, and the late-2018 selloff in financial markets. Currently, the ratio of unemployed Americans to job openings is lower than it has been in nearly two decades.
“There are more job openings in the U.S. than there are unemployed Americans," Davis said. “The last time was in 1999. There are a lot of differences between now and then, including the lack of qualified workers and pressure on wages, at 3 percent to 4 percent wage growth in some sectors of the economy.”
The Fed’s expected inflation target is roughly 2 percent annually, and “unlike previous periods, inflation is not too high and [not] above where the Federal Reserve wants it to be. That reduces the odds the Fed will be aggressive.”
Inflation is unlikely to break out over 2 percent, partly due to the credibility of the U.S. central bank and partly due to technology.
“In a global digital world, Moore’s Law and increased use of computers has reduced inflation by 0.50 percent. Oil prices have dropped over the past year. The Fed need not raise rates aggressively.”
Third, the selloff in financial markets in October, November, and December “increased the odds we’ll have growth this year. Why I say that is, a concern I’ve had is two years of considerable froth in financial markets. That created potential risk," Davis added.
Vanguard believes the stock market has gotten “back to fair value. If markets stabilize going forward ... that also reduces the odds of recession.”
Davis, who also works as head of investment strategy at Vanguard, added that 2019 is the first year the firm did not cut its returns outlook for a balanced portfolio.
“It’s the first time in a decade" that Vanguard did not cut its returns outlook, which currently remains at 4 to 5 percent annually for a balanced portfolio of equities and fixed income in the long term, he said. Global equity returns are expected to reach 6 to 7 percent annually over the long term, he added.
What could go wrong?
“The Fed may feel compelled to raise rates above 3 percent," he said. "Those risks have fallen. My biggest concerns are a significant slowdown already occurring in China, different from the past, and finally, trade tensions feeding into China weakness and threatening the United States.”
China’s economy has been growing at 5 percent, and in the next few months possibly could slow down to 4 percent annually, compared with China’s official target of 6 percent GDP growth.
“For the first time in 28 years, Chinese car sales fell by three million units,” he noted. “Which economy is suffering the most from trade tensions? China. Given the run-up in debt and consumer leverage, China was engineering a slowdown. Consumer confidence in China is extremely low. The trade tensions have taken that down to another level."
“We’re in for a period of volatility, so there will be nagging concerns of recession until China arrests this downturn,” he explained.
Policy uncertainty in the U.S. is “approaching that of 2011, when we had the fiscal crisis.”
If the government shutdown isn’t resolved by April, “by that time, if we’ve not seen greater clarity on trade tensions between U.S. and China, and the government shutdown, I think the weakness has the risk of spilling more significantly into the financial markets and the economy. But until that time, that’s not our call."
A tight labor market, indeed. Outside the Bellevue Hotel, Philadelphia sheet-metal workers had time to protest against Vanguard’s use of contractors including Worth Inc. on a new construction project at Vanguard’s Malvern corporate campus. The union’s retirement fund is invested with Vanguard.
“This is a slap in the face to all the men and women that earn a living wage, invest their pay ... into a retirement plan” with Vanguard, according to a flier the workers handed out on the street. About a dozen union members stood outside the hotel where Davis was speaking with signs reading “Shame on Vanguard."
Vanguard is constructing an addition of roughly 300,00 square feet, according to the Sheet Metal Workers Local 19 members. They also set up a larger-than-life inflatable “Fat Cat” mascot outside the hotel, which they used at a prior protest outside Holtec in Camden.