Parsing 2020: restated, third-quarter real gross domestic product increased at an annual rate of 2.1%. As well, consensus economic forecasts predict growth at a moderate pace. Inflation, as measured by the CPI, is expected to edge up. And unemployment is anticipated to remain below 4%. The business fixed investment will continue to slow due to geopolitical uncertainties and the impacts of falling freight traffic.
While the consensus forecast is typically believed to be a rough picture of what is to come, business cycles are irregular, and history has shown that the future can turn out differently than expected. We tend to move in crowds and weigh current and recent experiences more heavily than might be appropriate. It’s clear the Fed’s monetary policy has purposefully inflated asset values. Aside from trade and geopolitical risk, the biggest domestic risk is the continuing low-interest-rate environment and the distortions it is forcing on private equity investors as they search for investment alternatives.
Without a crystal ball, the economy’s current state is most likely the best indicator of next year’s events. But simply extrapolating continuing growth does not mean there is no risk. Asset valuations are highest at the top of a business cycle. Our outlook? Aviation traffic continues to grow. Boeing’s 737MAX will fly in 2020. Both air and rail freight markets will continue to operate in difficult environments.
Successful aviation and rail investment managers have to understand how their markets work and anticipate what will happen next. Being a successful economic policymaker is more difficult. Not only do they have to understand markets, but they also have to make everything turn out well. 2020 is an election year, so politics will influence economic policy. Interest rates will remain low and, even with a ‘Phase One’ deal, trade differences will continue past the fall elections.
The real risk? Government, business, and consumers continue to borrow. As long as borrowing is affordable it drives growth. But wealth gaps increase during asset bubbles, and populism emerges. In a classic asset bubble, interest rates are low, and debt rises faster than incomes. The combination produces accelerating asset returns and growth. Rising income, net worth, and asset values raise the capacity to borrow. It’s a self-reinforcing process. But as debt service payments become equal to or larger than the amount of money available to service them, the condition becomes unsustainable. In a world of higher prices and lower expected returns, the compensation for taking risk becomes too small.
The 2020 Challenge? Managing a transportation lease portfolio in a low-interest-rate environment with low premiums on risky assets. It’s dangerous to reduce the importance of valuation and effective management. Lease investment is a complex form of financing. If a lessee defaults, how much will you recover? The reason to estimate recoveries is it will tell you how to best structure your lease when you first originate it, and, it will tell you the best course of action to pursue if a default occurs. For extensive real-world experience, call RESIDCO.
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