2016-17 State of the Economy

For any business looking to enjoy a more profitable 2017, the economic stars are starting to align.

Major drivers of the economy, such as capital investment and housing construction, are expected to continue their modest but steady growth. And consumers should spend more money over the coming 12 months, thanks to increases in employment and wages.

“The economy should continue to strengthen in 2017,” says Kathryn Asher, associate economist in the research division of Moody’s Analytics. “The job market is posting impressive gains, vehicle sales have never been stronger, home sales and house prices have largely recovered from the bust, and the stock market is hitting new highs.”

The numbers tell the tale. Over the next 12 months, economists expect a 2.9 percent increase in the gross domestic product (GDP), or the total spending on goods and services by consumers and businesses. That’s above the American economy’s historic norm of 2.5 percent. It’s also a healthy increase from the 1.6 percent growth expected when 2016 numbers are finally tallied, and the 2.6 percent growth of 2015. (The lower 2016 GDP rate resulted from two unanticipated forces: a larger-than-expected inventory correction and a slide in energy-related investment).

Growing employment

A healthy economy ultimately means higher employment.

“The labor market expansion is in its seventh year, the longest uninterrupted period of job gains in recent history,” Asher says.

That expansion is expected to continue, with unemployment decreasing to about 4.6 percent by the end of 2017, down from the 4.9 percent recorded in late 2016. (Many economists believe an economy is at “full employment” when the unemployment level dips to 4.7 percent.) Thanks to the improved employment picture, the nation is finally starting to see signs of a wage acceleration that can only fuel additional consumer spending.

“A number of large companies, such as Walmart, have announced increases in base pay,” says Scott Hoyt, senior director of consumer economics for Moody’s Analytics. “That suggests tighter labor markets and issues in obtaining sufficient workers. And that bodes well for wage growth.”

Average hourly earnings are expected to grow by 3 percent in 2017, up from the 2.6 percent increase of 2016, which was a healthy rise from the 2.3 percent growth of the previous year.

Holding steady

Housing, a critical economic driver, is expected to continue to expand through 2017, albeit at a more moderate pace. Moody’s forecasts a 3.5 percent increase in housing starts in 2017, a de-escalation from the 9.7 percent of 2016, a pace which was slower than the previous year’s rate of 10.7 percent.

The inventory of available homes remains low as consumers continue to snap up the best deals. At the same time, constraints on mortgage credit availability are relaxing.

“Lenders are increasingly comfortable extending credit to borrowers with lower scores and smaller down payments,” Asher says. “This is a result of the solid job market and consistently rising house prices, which are closing in on record highs nationwide.”

Prices of single-family median homes are expected to rise some 3.8 percent in 2017, a slower pace than the 5 percent rise in 2016 and the 6.9 percent increase of the previous year.

Additionally, federal agencies have recently clarified their regulations, so lenders have felt more comfortable extending credit.

“Household formation is building, and that benefits retailers,” says Walter Simson, principal of Ventor Consulting. “People with new homes need ‘new everything.’”
The de-escalation of housing starts is caused not by a decline in demand but by limitations of supply.

“Residential construction has leveled off over the past year amid reports of skilled worker shortages,” Asher says. “There are other supply constraints, including buildable lots and credit access.”

Forward, but slowly

Thanks to the gradually improving economy, businesses are becoming more confident.

“Businesspeople have started to engage in longer-term strategic planning,” Simson says. “This is a major change since the years following the Great Recession when companies were too depressed to even schedule meetings to plan for the future.”

Manufacturers, in particular, are looking toward 2017 more favorably after coming off a fairly modest year.

“Our members are starting to see an increase in sales and are in the process of building inventories,” says Tom Palisin, executive director of The Manufacturers’ Association, a regional employers’ organization with more than 370 member companies.

Despite the better boardroom feelings, business investment, a key driver for the economy, is nothing to write home about. Many businesses burned by the Great Recession refrain from taking on too much risk.

“Businesses are expanding steadily rather than aggressively, with an awareness that things could go bad again,” Simson says. “In many cases, they are just playing catch-up for those investments they had deferred in prior years.”

Moody’s Analytics concurs that business investment remains a source of weakness, weighing heavily on overall growth. The reason? A profit picture that is darker than anticipated.

“Corporate profits have had a poor run recently because of lower oil prices and appreciation of the U.S. dollar,” Asher says.

Other factors include regulatory changes in the Occupational Safety and Health Administration and overtime pay, and economic turmoil in Europe. Corporate profits fell 3 percent in 2015 and are forecast to drop another 3.5 percent when 2016 numbers are finally tallied.

Labor costs

Margins for larger employers should come under additional pressure as a tighter job market increases wages.

“One of the biggest concerns remains the relative scarcity of skilled workers,” Palisin says. “About 10,000 baby boomers a day are leaving the workforce. The pressure is increasing to replace those individuals, but the pipeline is very thin. That, in turn, impacts growth prospects since companies are afraid they will not have the available talent for an upsurge in orders.”

Wage pressure is further increased by the ongoing trend toward reshoring, where companies bringing work back from offshore to the U.S. seek additional domestic workers.

“For companies serving the North American market, reshoring can make a lot of sense,” Palisin says. “The goal is to improve quality by keeping production close to the R&D and engineering locations. Reshoring is also stimulated by a desire to reduce shipping costs and protect intellectual property. Also, increasing labor costs in China have made offshoring less attractive.”

Manufacturers also enjoy quicker delivery time with domestic production, Simson says.

“Companies would rather have a four-to-six-week delivery of an item made here than a three-month delivery of something made overseas, even though the price might be lower,” he says.

To help solve the labor shortage problem, many companies are more aggressively pursuing internal training, launching apprenticeship programs to grow from the inside. But competition for the remaining workers remains a key driver of wage growth.

“Manufacturers are having a hard time keeping this year’s worker with last year’s wages,” Simson says. “Many are going for higher quality workers, lower turnover and slightly higher wages.”

Rising labor costs, of course, sharpen the already keen desire to get the most benefit for each labor dollar invested. The need to maximize productivity has gained additional urgency with the recent changes in federal overtime law, which was delayed from taking effect Dec. 1 after a Texas judge’s November ruling in a lawsuit to block it.

“Increasing costs due to the recent reclassification of exempt workers has caused many employers to take a hard look at the productivity of individual employees,” Palisin says. “If the return is not there, then employers are reducing their workforces.”

For all of these reasons, labor costs will likely continue to pressure margins over the coming 12 months.

“Corporate profit growth will remain modest in 2017 as we look for a 1.4 percent gain,” Asher says.

Retailers benefit

The improved economy should fuel more sales for retailers.

“Our view is that 2017 looks better than 2016 for retail sales,” Hoyt says.

Core retail sales are expected to increase by 5.4 percent, up from the mediocre 4.2 percent increase expected for 2016 when figures are finally tallied. (Core retail sales exclude volatile revenues from auto sales and gas stations.)

The healthy employment and housing sectors contribute to generally positive feelings at large.

“Consumer confidence has remained remarkably stable over the last year and a half,” Hoyt says.

That’s good for retailers because confident consumers tend to be aggressive shoppers. And when they want to open their wallets wider, banks are cooperating.

“An ongoing support for retailers is the increased availability of credit,” Hoyt says. “We are seeing an acceleration of credit card balance growth, and that is a positive sign.”

Retail results for 2016 were on the weak side of historic norms and were pretty much flat with 2015. Hoyt attributes the disappointing performance to deflationary pressures.

“All indices of retail prices, not just energy, showed an unusual lack of pricing power in 2016,” he says. “We did not anticipate that a year ago.”

When deflation is factored out of the 2016 results, Hoyt says, the year’s retail sales increase would be nearly a percentage point higher. And the deflation-adjusted increase for 2017 is expected to compare favorably with periods of healthy retail activity, such as the decade of the 1990s and the years just prior to the Great Recession.

No recession

What are the chances of a recession kicking in over the next 12 months? One can easily spot troubling signs, such as the pressures on corporate profitability. Another is the de-escalation of employment growth.

“Job growth slowed in 2016 to an average pace of 182,000 per month, compared with 240,000 in 2014 and 2015,” Asher says. That moderation is expected to continue: “We expect the labor market recovery to persist with monthly gains holding below 200,000 on average over the next year, supported by a strengthening housing market and broad-based service growth.”

None of these factors, however, is expected to tip the nation into recession. Moody’s expects business investment to cease being a drag on growth over the year ahead as unanticipated excess inventories get back in line.

“In addition, consumer spending will turn more supportive to investment in the next few quarters,” Asher says. “Stronger consumer spending bodes well for industrial production, and as capacity utilization increases, so too will the pressure on businesses to invest.”

Finally, the employment picture remains positive.

“The moderation in job growth should not be alarming,” Asher says. “It is natural for this to occur as an expansion ages and the economy rapidly approaches full employment.”

Economists do not expect the economy to soften in the foreseeable future.

“While job growth will slow, we don’t expect the economy to fall into a recession soon,” Asher says. “Odds are that the current expansion, which is already one of the longest, has a way to run.”