The Year Ahead

7 forces shaping equipment finance and the U.S. economy in 2020

WHAT’S THE OUTLOOK FOR 2020?

In the year ahead, we expect the economic headwinds that were building throughout 2019 to persist (see below). Political uncertainty will almost certainly increase in 2020 as the country prepares for another bruising election, and the global economic slowdown that began in 2019 is likely to worsen in 2020. On the bright side, the U.S. labor market remains healthy, and consumers are well-positioned to keep the economy moving in the right direction. But overall, the economic picture for the next 12 months is cloudy, and slower growth is likely.

Here are seven key industry, policy and macroeconomic factors to watch in 2020.

1 The U.S. economy will weaken further in 2020, but growth should remain positive. Although the U.S. economy was already showing signs of strain in early 2019, the conventional wisdom was still mostly positive until mid-August, when the 10/2 yield curve inverted. Interest in the “R-word” immediately increased—Google Trends shows that the search term “recession” spiked to levels not seen since 2008–09—and the narrative quickly shifted. However, since that time, Q3 GDP growth beat expectations, the yield curve returned to positive territory and labor markets stayed strong through the fall and winter. As a result, worries of a downturn have ebbed in recent months.

While we agree that talk of a near-term recession was likely overblown after the yield curve inverted—after all, recessions typically don’t begin for 12–18 months following an inversion—we expect the economy to continue to slow in 2020, primarily due to two factors:

• First, the industrial core of the economy remains weak. Domestic manufacturing output is below its year-ago level, the ISM Manufacturing PMI has signaled contraction for five months and fell again in December and new orders of core capital goods (a leading indicator of next-quarter business activity) have posted negative Y/Y growth in four of the last five months. These data do not point to a manufacturing sector on the mend, though there is a possibility that the contraction has bottomed out.
• Second, business confidence is falling, and firms in general appear less willing to take risks and invest in the economy due to a combination of factors, including lagging corporate earnings, lingering trade uncertainty, manufacturing weakness and a slowing global economy. None of these headwinds are likely to recede this year; indeed, uncertainty is likely to be heightened for the business community given the 2020 election and its potential ramifications on economic policy.

The good news, however, is that consumers have been resilient to these headwinds and continue to propel the economy forward. Jobs remain plentiful and wage growth is solid, so it is no wonder that consumers remain confident in the economy. Indeed, the 2019 Equipment Leasing Finance Industry Horizon Report, produced by the Equipment Leasing & Finance Foundation in partnership with Keybridge, demonstrates that consumer strength is the primary reason why the Foundation-Keybridge Equipment Finance Industry Recession Monitor continues to signal that a recession in the next three to six months is unlikely. That said, there have been some signs that consumer spending may be easing. For example, according to Mastercard data, 2019 holiday retail sales grew at the slowest annual rate (+3.4%) in more than five years. As such, a “growth pause” in which the economy slows to around 1% annualized growth for multiple quarters is a distinct possibility. Though we expect the economy to fare a bit better than this—our projection is for 1.7% growth in 2020—we still anticipate reduced economic activity compared to last year.


2 Equipment and software investment will remain sluggish.
Investment in equipment and software (E&S) is a key component of GDP and the lifeblood of the equipment finance industry. After robust growth in 2018, E&S investment slowed markedly over the course of 2019 and contracted in the third quarter for the first time since early 2016. The poor performance was driven by several factors, including waning business confidence caused by unresolved trade tensions and a slowing global economy. For example, Business Roundtable’s CEO Economic Outlook Survey Capex Sub-index has declined for six straight quarters and is at its lowest point in three years.

Looking ahead, we expect E&S investment growth to remain sluggish in 2020. As previously discussed, the U.S. manufacturing sector continues to face recession-like conditions, which will provide a weak jump-off point for investment in 2020. Moreover, we do not expect that global growth will rebound sharply, that the recently announced Phase I trade deal with China will lead to fundamental improvements in overall trade conditions, or that business confidence will improve markedly. Combined with the reality that 2020 is an election year with potentially major implications on U.S. economic policy, many businesses are likely to be in wait-and-see mode with respect to investing in new capital. The Foundation’s 2020 Equipment Leasing & Finance U.S. Economic Outlook projected that E&S investment will expand 1.1% this year, down from an estimated 3.6% in 2019.

3 U.S. oil-sector investment will continue to face headwinds in 2020.
Despite U.S. crude prices stabilizing around $60/barrel at the end of 2019 and record-high crude oil production, the outlook for the U.S. oil sector has soured notably. Unlike the oil-sector downturn of 2015–2016 (which was a result of plunging global oil prices) the current slowdown is due to weakening production fundamentals, particularly in areas of the United States that depend on production from fracked wells.

Production has been declining more quickly than many exploration and production firms forecasted, and investors are increasingly demanding that firms focus on profitability rather than production volume. The drive for profitability and positive share-price return has resulted in a sharp cutback in mining and oilfield investment and slower production growth, as evidenced by the domestic rig count, which has fallen precipitously over the course of 2019 and is now at its lowest point in more than two years.

2020 is likely to be another year of consolidation for the oil sector. Firms continue to slash capex plans as they seek profitability. Meanwhile, the global economy remains sluggish and faces several downside risks, which means that upside potential for oil prices—and the U.S. oil sector—will be limited in 2020. One potential exception to this relatively bleak forecast for the U.S. oil sector is the possibility of a protracted conflict with Iran or Iranian proxies in the Middle East. Given the volume of oil that transits the Strait of Hormuz daily and Iran’s demonstrated willingness to target oil infrastructure (especially in Saudi Arabia), there are ample opportunities for Iran to disrupt the global supply of oil, which would put upward pressure on prices.



4 Risks to the global economy will skew to the downside.
Several major economies are showing signs of strain, in no small part due to China’s structural slowdown and an escalating trade war. In Asia, India’s economy is suffering declines in manufacturing, consumer spending and trade, and outside observers are questioning the veracity of government data (raising the possibility that the Indian economy actually may be weaker than it appears). Japan and South Korea face substantially weaker demand for their exports, a trend that is unlikely to reverse while the U.S. and China remain at odds over economic and geopolitical issues.

Meanwhile in Europe, recent data in Germany has dashed hopes of an emergence from a multiyear manufacturing recession. Industrial-sector performance continues to disappoint and there have been some signs that the weakness that was previously confined to the manufacturing sector has begun to spill over into the consumer sector. The main culprit is the ongoing downturn in the global automotive sector, which accounts for some 7% of eurozone GDP. Waning Chinese demand, new E.U. emissions standards and ongoing trade tensions will all contribute to ongoing weakness in the E.U. auto sector, which will be a drag on the E.U. economy and depress demand for U.S. exports.

5 The confrontation with China will be the defining geopolitical narrative of 2020.
President Trump’s anti-China stance remains a key plank of his policy platform, and there is no better manifestation of this stance than the trade war with China that began in early 2018. The conflict between the world’s two largest economies has dampened profits and confidence among businesses both large and small while roiling financial markets that seem eager to grab onto any piece of positive news that emerges from the talks. However, what started as a trade fight over China’s favoritism of domestic firms, intellectual property theft and the trade deficit has morphed into a strategic confrontation on economic, political and geopolitical fronts. As this conflict encroaches further into other parts of the U.S.–China relationship, it will become more and more difficult to resolve.

Making a potential resolution to the U.S.–China conflict more difficult to reach is the Administration’s “go it alone” attitude toward trade negotiations. The United States recently opened trade fights with allies like France, Argentina and Brazil with little advance warning. These actions have increasingly isolated the White House from global partners who, under different circumstances, may otherwise support a trade confrontation with China. This apparent retreat from the world stage and escalation of various trade fights are representative of the paradigm shift in the United States’ economic and foreign policy posture that we suspect will characterize 2020, and possibly beyond.

In December, the United States and China agreed to a Phase I trade deal that exchanged reductions in tariffs on Chinese goods for increased purchases of American agricultural products and unspecified “structural” changes to the Chinese economy. Financial markets jumped in response to this news, which came as a welcome departure from the tit-for-tat escalation that characterized much of 2019. Though this initial agreement may relieve some of the pressure on business confidence in the short term, we believe it is unlikely to resolve any of the larger issues that stem from China’s state-run economy.

6 Trade wars will cause supply chain disruptions.
As discussed above, the U.S. trade war with China quickly devolved into a broad, strategic confrontation on several different economic, financial and geopolitical fronts. This has created significant uncertainty for multinational firms that operate in China. The effects are likely to persist: surveys show that most respondents expect that the tariffs and retaliatory actions will stay in place beyond 2020. This “no end in sight” outlook has hurt American companies in China, as 75% of respondents to an American Chamber of Commerce in China survey say their businesses have been negatively impacted by U.S. and Chinese tariffs.

In response to this uncertainty, firms are canceling investments into China at a greater rate than in years past, and a significant number of firms are either actively considering relocating their China-based manufacturing facilities or have already done so. While these may seem like positive developments for the President’s “America First” trade policy, few firms are planning to shift China-based manufacturing capacity to the United States. Rather, American firms are moving their supply chains to other low-cost manufacturing hubs in Southeast Asia, Mexico and India. These realignments are unlikely to be reversed after December’s Phase I deal due to lingering uncertainty and sunk costs. Further, firms have reported difficulty in securing quality suppliers and finding skilled labor in these new locations—frictions that will reverberate through supply chains around the world and could dampen profits and business confidence.

One positive development on the trade front is the likely ratification of the U.S.-Mexico-Canada Agreement (“USMCA”). North American firms previously faced substantial uncertainty regarding their cross-border trade and investment flows due to the Trump Administration’s threat to withdraw from NAFTA. Business confidence—especially among firms that depend heavily on North American supply chains—may benefit as a result.

7 Deglobalization will lead to weakening power of international institutions and norms.
Part of the Trump Administration’s “America First” platform is a general distrust of international organizations like the World Trade Organization (WTO). This distrust originates within the office of the U.S. Trade Representative, Robert Lighthizer. Mr. Lighthizer believes that the WTO has repeatedly overstepped its mandate in terms of adjudicating international trade disputes and has encroached on the sovereignty of the U.S.

Throughout 2019 the United States chose not to appoint new adjudicators to the appellate body responsible for resolving appeals of WTO rulings, continuing a trend initiated by the Obama Administration in mid-2016. This pattern of obstruction came to a head in December 2019, when two of the last three appellate judges’ terms ended, throwing the WTO into crisis. The WTO is essentially toothless now, as it lacks the ability to issue rulings on appeals brought by its members.

The WTO is meant to be an organization that establishes a framework through which firms across the world can compete on a relatively level playing field. WTO rules guide the flow of more than $20 trillion in annual global exports each year and influence investment decisions in every corner of the globe. U.S. firms, even those with relatively little direct exposure to international markets, will feel the effects of a dormant WTO. Foreign countries with less free-market-oriented economies will likely find it easier to act in bad faith. Similarly, U.S. multinationals are unlikely to invest in foreign countries if they fear that the protections afforded by the WTO are no longer available. Together, these factors are likely a net-negative for business confidence in the U.S. and for total global trade volumes, but they may ultimately help achieve the stated goals of the Trump Administration’s trade policy: reshoring manufacturing capacity and punishing nations believed to have taken advantage of the United States in prior trade dealings.