Economic Update, 2017 Q3

By Dennis Boone

Uncertainty, that killer of business growth, is feeding on a number of current economic trends. But that doesn’t imply a reduction in commercial lending or investment opportunities.

With the final quarter of 2017 almost upon us, economic news is brimming with tales of the Good, the Bad and the Ugly.

The Good:  In both June and July the Conference Board’s leading economic index surged 0.6 percent, then 0.3 percent, signaling the possibility of continuing growth through the end of the year. The index is a broad measure of how well the economy is performing. 

 The S&P 500, which bottomed out during the Great Recession at 666, is on the threshold of 2,500—an increase of 275% in nine years, and considerably higher than its historic average of about 10%.

The Bad: A years-long arc of debt reduction by consumers was interrupted in the second quarter; the Federal Reserve Bank said consumers were increasing their exposure with mortgages, credit cards and car loans, indicators that fewer dollars will be available for discretionary spending on retail, travel and entertainment.

 The hiring boom is dissipating; in the first half of this year, the economy added 1.29 million jobs, according to the Department of Labor, but that’s down from the 1.46 million added in the final seven months of 2016. And with unemployment at a 16-year-low, how much lower, realistically, can it go?

The Ugly: The damage inflicted by Hurricane Harvey in Texas and Hurricane Irma in Florida could top $300 billion, but some estimate—the equivalent of more than 1.5% of the nation’s GDP. That’s great news for roofers and contractors, perhaps, but a careful reading of Bastiat might suggest a less rosy outcome for the nation overall.

Those are just a few of the myriad ingredients in a statistical stew that the region’s bankers and wealth managers are sampling. And indications are that commercial clients, even before the impact of the hurricanes had been fully gauged, were trending loan-shy.

The reasons? Uncertainty over where Congress will go with healthcare reform—yet another proposed replacement for Obamacare surfaced this month—as well as with President Trump’s calls for significant tax reform. Ambiguity on those two fronts alone creates enough uncertainty to dam-
pen all but the most pressing business issues that require additional debt, bankers say.

“Some of our clients appear to have some hesitancy in making long-term investments until more is known,” said Mark Jorgenson, president of community banking for U.S. Bank. “We have seen increased competition in the form of more aggressive pricing and loosening credit covenant structures, and that has dampened our optimism for increased loan volume on our books for the coming months.”

At Arvest Bank, market president Mark Larrabee cited a recent slowdown in both commercial and CRE activity. “I believe the uncertainty around the ACA and taxes, as well as an extremely tight labor market, is causing business owners to rethink their growth plans,” he said. “Additionally, activity in the residential market has slowed down from earlier in the year, which may cause a decline in new home construction even with a tight supply.”

Nonetheless, he remains optimistic that Arvest will be able to grow its loan portfolio over the next 12 months “at a high-single to low-double-digit rate.”

Dale Klose, who is leading PNC Bank’s entry into the competitive Kansas City market, shared some of that optimism. “Corporate and institutional banking, along with commercial real estate lending volumes should continue to gradually improve into 2018,” he said. He attributed that to the comparatively low interest rates, modest improvement in the business investment climate, and generally low vacancy rates for commercial properties.

Bill Ferguson, CEO of Central Bank of the Midwest, noted that with C&I in particular, a number of companies are sitting on quite a lot of cash or have paid down their lines significantly. “They will likely draw down some on their lines prior to year-end so moderate growth is expected,” he said.  While some borrowers await “go” signals from Washington, others are moving, especially on the CRE front. “We continue to see strong demand in hospitality, multi-family, and senior housing,” he said. “We are monitoring our CRE growth closely because most prognosticators feel that several segments of CRE will likely start facing some headwinds during 2018.”

One other factor that could influence borrowing patterns, banker say, is the potential for the Federal Reserve to resume its long-planned ratcheting up of interest rates.

“We were planning on one more increase in December but now that seems to be becoming more unlikely,” said Ferguson. “Looking into next year, if the Fed raises rates at all it is likely to only be one time in the first six to eight months.” At this point, he said, the Fed has limited options to stimulate the economy with rates so low. “It appears the yield curve will continue to flatten since inflation is so low and is not anticipated to increase very much,” he said.

Larrabee said Arvest is expecting the Fed to act in the coming months. “While the inflation rate remains low, the tight labor market and 2.75-3 percent growth implies an ability for the economy to absorb higher rates,” he said. “The modest increases expected are not going to create a traumatic shock. Inflation can ignite quickly and the Fed’s goal is to keep that from happening.”

Jorgenson, as well, believes rates will tick north. “We think the Fed retains a slight bias to increase rates mar-ginally in the next 6 to 12 months,” he said.
“The near-term focus of the Fed is on reducing its balance sheet. It has done a good job of telegraphing its intent to do so, and the market has taken this all in stride.

 But at the expected “wind-down rate,” Jorgenson said, it will likely still take the Fed nearly four years to achieve its desired balance-sheet level of assets.

The warning signs that do exist at this point shouldn’t obscure the potential for opportunities ahead, executives from financial-services firms say. That applies as much to wealth management and investing as to banking, executives say. And for investors in particular, a bit of perspective might be in order.

Jonathan Thomas, CEO at American Century, noted the dark clouds that gathered in 2007 before the financial crisis of 2008.

“The housing bubble had burst, the default rate on subprime mortgages skyrocketed, major financial institutions were collapsing and the S&P 500 lost about half of its value over a 17-month period,” he says. “Investors were naturally very pessimistic and pulled significant assets out of the markets to avoid further losses.”

But those who stayed in the market or bought at the bottom, he points out, went on to achieve significant returns as the S&P 500 skyrocketed since then.

“Those who panicked locked in their losses and probably shortchanged long-term savings goals like retirement,” Thomas said. “This reinforced with me the importance of making sure our clients—particularly our retail investors—have an investment plan based on risk tolerance and time horizon.”