The 4th Longest Expansion in the History of the US is Not a Sign of Recession

By David Lieberman, Portfolio Manager Core Dividend and Global Balanced

October 24, 2016

The advance GDP report for Q3 GDP will be released on Friday and consensus estimates are for real GDP growth of 2.5%, higher than the fairly slow 1.1% pace from the first 2 quarters of the year. GDP growth has been slow, but steady, while other measures demonstrate growth that is stronger than what GDP suggests. In all, this expansion has now lasted over 7 years and is currently the 4th longest expansion in the history of the US. However, many of the traditional drivers of economic growth have yet to reach the late stages of their cycles. While it is incredibly difficult to forecast much beyond a year, there is nothing to suggest a recession in the year ahead.

The fact that the US is now well into its 7th year of expansion is often cited as a reason for a likely recession in the near future. But this point ignores the fact that economic cycles have been getting longer over time. In all, there have been 33 expansionary periods since 1858. During the years from 1850 until 1900, the average expansion lasted for only 2.3 years. From 1900 until 1950 that gap increased to a still short 2.6 years. However, from 1950-2000, the gap increased another 65% to 4.3 years. In fact, all three of the longer expansions have taken place since 1970.

This improvement in expansion duration was largely driven by the shift in the US from a manufacturing to a service based economy as well as improved efficacy of various economic levers such as monetary policy.

The US economy still has several drivers pointing to further expansion, rather than signaling late-stage weakness. A closer look at the auto, housing, and energy sectors suggests further expansion to come instead of impending recession, as some fear.   While the auto sector has finally rebounded and we’re now selling as many new vehicles as we did prior to the last recession, the average vehicle has aged tremendously and is now nearly 12 years old.

Even though improvements in quality help support some boost in longevity, the 2008 recession led to the average vehicle age increasing about 5 times faster than its traditional rate largely due to the near 40% drop in new vehicle sales in 2008-2009. This gives us ample room for new car sales to continue at these levels over the next few years as these older models are replaced.

Housing, too, remains in the relatively early innings of a recovery. New housing units of about 1.5 million are needed each year just to keep pace with household formation and demise of older units. Yet housing starts have still not approached this level and housing shortages are becoming more common throughout the country. This is driving up housing prices and while home builders would love to build more, they are having trouble finding the labor to do it. This too is bullish for the economy.

Oil market fluctuations have historically been another factor behind the onset of recessions, and those typically have been prompted by a sharp oil price spike. Not only is oil a much smaller portion of US GDP today, but it also is unlikely to rise sharply in price from these levels because the advent of new drilling technologies in the US has lowered extraction costs and has largely removed OPEC’s ability to set prices by constraining supply. If prices rise much from current levels, US producers can simply expand supply—and there is plenty of it—so we should expect energy prices to remain low, which should continue to support consumer spending and keeps costs down for US manufacturers.

But even as we continue to see solid signs for continued expansion, we are also experiencing unusually low interest rates even as inflation and wages tick higher. We remain concerned that if the Fed does not begin to raise rates soon, it may be forced to raise them more significantly—and over less time—in the not too distant future. In the past 70 years, the US has never had a Fed Funds rate below 3.5% when the unemployment rate was 4.9% or lower. So we are clearly in historically unprecedented times. While the US and the world are growing more slowly, perhaps warranting a lower level of interest rates, if the Fed is forced to catch up quickly, this could cause a sharp slowdown in capital investment which would curtail the expansion. Still, this too seems like a lower probability, since the Fed is keenly aware of this risk and inflation is unlikely to rapidly run away from us.

It is premature to assume that the late cycle nature of our expansion will prompt the next recession. Many of the indicators of economic growth remain healthy and there is currently no evidence of a recession over the next year.

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