How Close to the Edge Are We?

LOS ANGELES—It’s a question on everyone’s mind: When it comes to the economy, how close to the edge are we? During the plenary session at the Americas Lodging Investment Summit (ALIS) here, economists took a closer look at that topic. Moderated by Simon Hobbs, LPL financial advisor, California Financial Partners, “The Economist Outlook” featured Richard Barkham, chief global economist/head of research, CBRE, and Ryan Severino, chief economist, JLL.

Hobbs set the stage by looking at the S&P 500. “This market doesn’t think there is a recession this year,” he said. “It believes the global economy will reaccelerate, and there will be a reacceleration of corporate earnings.”

Hobbs pointed to the Fed cutting rates as a major reason why. “It was raising rates; last year, it cut rates three times, and we’ll see what they do on Wednesday,” he said.

“In answer to the question, I would say the stock market thinks we’re not [close to the edge],” he said. “That’s not to say [the stock market is]correct.”

Barkham pointed out, “We are in a very extended cycle. It does not look like there’s an end to it. I think that’s largely because of the absence of inflation, [which]is good for ordinary Americans, but it creates problems for the supply side of the economy. We’ve got new supply to be absorbed and not much pricing power. There are structural shifts in the economy and business models are changing, rendering old business models obsolete. And, of course, the absence of inflation and the general lowness of interest rates pushes the stock market to all-time highs, and that makes the economy vulnerable to random shocks out of nowhere.”

For his part, Severino said that economy is in a good—not great—place as far as underlying momentum goes. “Some of it is expectations versus reality,” he said. “If you look at the stock market, clearly it’s expecting things to continue operating pretty well. And I’m not specifically saying that it won’t, but history shows when you end up with valuations like this, it’s usually a harbinger that returns will not be as good moving forward. Maybe it’s not necessarily a case of things deteriorating, [but]that expectations are somewhat elevated relative to what reality can actually produce.”

The panel took a look at geopolitical events like the coronavirus and President Trump’s impeachment trial. Barkham noted that if you look at what happened with SARS and Zika, these events had an impact locally, but not globally. “Certainly, it can affect travel and local areas. Will it knock a powerful economic expansion in the U.S. off its tracks? I don’t think so,” he said.

Severino pointed out that impeachment has a limited sample size, but that the data set from prior impeachment proceedings and impeachment threats does reveal “it really does depend on the underlying economy.”

“We get this question a lot: Will geopolitics derail the cycle?” Barkham said. “Geopolitical events might weaken the quarter’s growth, they might have a specific local impact, but they have very little impact on the overall trajectory of the U.S. economy. This is not to say cycles can’t come to an end; clearly they do. But the cycles come to an end largely because of interest rate rises.”

“You’re looking at a situation now where it’s hard to see the typical imbalances that build up that could potentially end the cycle, that might cause the Federal Reserve to raise interest rates a little too aggressively,” Severino said. “If anything, the Fed is…clearly not acting in a manner that is causing a lot of consternation right now. You’re not seeing the kind of imbalances in the financial part of the economy that normally tend to signal the cycle is nearing the end.”

Severino noted that a lot would depend on what we see from the economy in the first half of the year. “I wouldn’t be surprised if the Fed decides to cut one more time or if the Fed decides to do nothing,” he said. “It depends on what they see.”

According to CBRE, the U.S. economy is predicted to grow by 2% in 2020. “There’s a little bit of a weakness from last year that will flow into this year,” Barkham explained. “Corporate sentiment is rebounding sharply, but what we need for full-fledged growth in the economy is some capital expenditure. I think there is pent-up demand for that in 2020, but the U.S. presidential election usually brings in a little uncertainty. Some of that weakness in CapEx is going to hang around.”

But, he added, “two percent is a solid rate of expansion.”

As for the hotel industry in particular, he said, “This relatively low growth of RevPAR below inflation at a time when you’ve got rising costs means everyone will have to be very cost focused. Lodging profits are still reasonably robust because occupancy is so high. But if people aren’t going to work…on how to be more efficient, they’re wasting their time.”

And how could the 2020 U.S. election affect the economy?

“It’s difficult to unseat an incumbent president when the economy is growing,” Barkham said. “This is good for business friendliness in terms of legislation, but it might involve a flare up in trade wars. My feeling is Trump will now take on Europe. In particular, he has the German auto industry in his sights.”

Severino stressed the importance of uncertainty. “When there’s uncertainty about the outcome and people believe policy decisions could be different depending on the outcome, they might be circumspect in how they approach things. Businesses tend to be more cautious about spending,” he said. “We don’t know who the Democratic nominee will be—and they have different views on issues—and we don’t know how the ultimate nominee will fare relative to the incumbent. If people are uncertain enough about the outcome—this stuff on its own tends not to disrupt the cycle, but at the margin, could we see people behaving and spending in a more circumspect manner? Sure. It has certainly happened in the past when there’s been that kind of uncertainty. When I look at the economy downshifting a bit, it’s a contributing but not overriding factor. It’s not something to discount.”