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Economic Impact: The economy is performing well but are there signs a possible recession is looming?

A shopper checks out holiday ornaments inside the Target store at 9001 Staples Mill Road in Henrico County on Nov. 19, a few days ahead of Black Friday.

Over the past month, many analysts have started to talk about the possibility of a recession looming in 2019.

And with good reason.

All three major stock market indices finished 2018 with their worst annual performance since 2008.

The S&P 500 ended the year down 6.24 percent, the Dow Jones Industrial Average was down 5.6 percent, and the Nasdaq composite finished down 3.9 percent for the year. The Dow fell 9 percent in December.

If the stock market is falling, then investors must believe that the sale of goods and services are going to decline in the future to the degree that profits fall. That is a recipe for recession.

Another sign of looming recession is that parts of the yield curve are inverted.

Interest rates for the 5-year Treasury have been higher than the shorter-term maturities such as the 1-year Treasury over the past few weeks.

An inverted yield curve often proceeds a recession as the Federal Reserve is pushing the target federal funds rate higher, which causes 3-month bills and short-maturity Treasuries to rise above the longer-term 10-year Treasury.

The full Treasury curve is not yet inverted, but if the Fed increases the federal funds rate too quickly, short-term interest rates could rise faster than longer maturities, which would invert the yield curve.

Given the recent uncertainties in economic growth, we expect the Federal Reserve to increase the federal funds rate only two times in 2019, which will likely flatten — but not invert — the yield curve.

But even that measure may not quiet the chatter about a recession.

Surprisingly, these signs are occurring during a time when the economy is performing well.

Although official numbers have not yet been reported, lower taxes, low unemployment and rising wages most likely gave retailers a strong holiday selling season. The consumer sector is important because it makes up about two-thirds of gross domestic product.

When consumers are buying, retailers need to replenish their inventories, and that leads to more orders for manufacturers that then give employees more hours to work or employ more people — a continuous cycle that supports economic growth.

Although business cycles don’t die of old age, there are a couple of concerns to keep an eye on in 2019 and 2020.

The first is business investment in plants and equipment. Corporate tax cuts and reductions in regulations that were ushered in with the Trump administration led to increased investment by businesses in new plants and equipment.

Aside from the increased sales to firms that construct plants and manufacture equipment, business investment will ultimately increase productivity, which enables the economy to grow faster.

Increasing productivity growth is critical to boosting the potential growth rate of the U.S. economy and improving living standards. This is where Trump’s lower corporate tax rates and reduced regulation have supported faster GDP growth.

However, investment in plants and equipment slowed to a 2.5 percent annualized pace in the third quarter from 8.7 percent in the second quarter.

This is an indicator that should be watched closely.

If it does not rebound in the next few quarters, then it may reflect businesses’ lack of confidence in future growth due to other issues.

Another issue eroding business confidence might be trade tension, which has gradually escalated with China over the past year.

Based on the trade volume between the two countries, close to half of imports from China and 85 percent of U.S. exports to China are subject to higher tariffs than in early 2018 after three rounds of tariff increases.

During the recent G20 summit in Argentina, the U.S. and China agreed to delay the implementation of the latest 25 percent tariff set for this month for 90 days.

While the market welcomes such temporary reprieve, additional tariffs as well as the uncertainty of further tariffs could hinder growth in the U.S.

Another issue may be labor shortages. With an unemployment rate at 3.9 percent in December, some firms might be short-staffed, which could also hinder growth or lead to wage increases.

Despite these uncertainties, I still expect the national economy to grow through July, which is when it would surpass the longest expansion on record at 121 months.

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