Retailers will enjoy brisk economic tail winds in 2019. A strong labor market will inspire liberal spending, while a robust business climate fuels higher corporate profits. At the same time, economists are starting to see early signs of an inevitable correction.

“The coming 12 months should be a good year for retailers,” says Scott Hoyt, senior director of consumer economics for Moody’s Analytics. “Core retail sales (which exclude the volatile auto and gasoline segments) are expected to grow a healthy 4.7% in 2019.”

Happy shoppers are driving the favorable retailing environment. “Consumers seem to be euphoric right now,” said Hoyt. “The fiscal stimulus in the form of tax cuts, as well as the tight job market, mean there are very few negatives when it comes to consumer fundamentals.”

Economy booms
The healthy consumer sentiment reflects the energies of a larger economy that is still growing. “The business cycle has entered its boom phase,” said Sophia Koropeckyj, managing director of industry economics at Moody’s Analytics. The Gross National Product (GNP), the most commonly accepted measure of economic growth, is expected to grow at a 2.7% clip in 2019.

Despite the generally sunny outlook, the GNP forecast represents a modest deceleration from the 3.0% growth anticipated when numbers are finally tallied for 2018. The 2019 retail sales growth estimate is also a deceleration from the 5.0% surge of 2018.

“There are several reasons for slower growth in 2019,” said Hoyt. “The largest is that deficit-financed tax cuts at the start of 2018 lifted growth. No such support, in terms of an additional increase in after-tax income, is expected in 2019. Job growth will also be slower because of there being fewer available workers.” Finally, Hoyt noted that interest rates will likely be higher, a factor that can have a softening effect.

Shelf prices rise
Retailers, for their part, are largely relieved of a problem prevalent in the marketplace a year back -- the inability to raise shelf prices. “Lack of pricing power is still a concern, but is not as big of an issue now,” said Hoyt. “Retail prices actually began to rise a bit in the first half of 2018, for the first time in three years. That’s most likely because of the tight labor market and the resulting toleration for price increases by shoppers.”

Indeed, pricing increases are expected to be the key to success in the months ahead. “Growth will be more price driven in 2019 than in 2018,” said Hoyt. The need to increase revenues largely by boosting prices rather than moving more merchandise accelerates a trend that began in 2018.

Favorable as it seems, the bright revenue picture has not been shared by all retail players. “The renaissance of retail has been uneven,” said Bob Phibbs, a retail consultant based in Coxsackie, N.Y. “2018 was a mixed bag, with legacy players having a harder fourth quarter, and lowering their outlook toward the end of the year.”

Those merchants who came out on top, according to Phibbs, invested early in a multi-channel sales approach. “The successful retailers went after shoppers in every buying pattern, whether that meant selling in store, online or letting them order online and pick up in store, or even delivering to their homes. For the ones who started looking at digital sales 10 years ago, 2018 was the year their approach finally started to bear fruit.” The same secret sauce will work in 2019, he said.

Employment grows
The nation’s shoppers are opening their wallets wider in response to a happier jobs picture, one that should only brighten in the months ahead. Moody’s expects unemployment to drop to 3.4% by the end of 2019, down from the 3.7% recorded at the end of 2018. (Moody’s Analytics first declared that the economy had reached a state of what is often called “full employment” with its 4.1% showing in 2017).

“The fundamentals of the labor market look good at least into the mid-year of 2019 and probably longer,” said Hoyt. “The nation is adding jobs faster than the growth in the wage-earning generation, so we expect a further tightening of the labor market in 2019.”

More jobs mean more wages, so shoppers will have more cash to spend. Average hourly earnings are expected to grow by 3.2% in 2019, up from the 2.8% of 2018 and the 2.6% of the previous year, according to Moody’s.

“Rising wages are very good for the economy,” said John Manzella, a consultant on economics and global business, Buffalo, N.Y. “The more disposable money consumers have, the more they spend, and consumer spending represents 70% of the nation’s economy.”

The growing flurry of paychecks seems to be a more important consideration for people than any negative economic news. “Consumers are not worried about the effects of a possible trade war, or gridlock in Washington, or the rise in gasoline prices that has taken place over the past year,” said Hoyt.

Housing rebounds
A powerful driver of consumer sentiment and economic growth, the housing market, should deliver good news in 2019. Housing starts are expected to rise by 19.4% in 2019, a substantial increase over the 7.0% expected to be clocked when 2018 are finally tallied. Median home prices should rise by 2.7%, slower than the 4.8% of 2018.

The challenge for home builders is finding enough workers. “Residential construction as a whole remains bedeviled by a shortage of capacity,” said Koropeckyj. “The unemployment rate for experienced construction workers is at a record low of less than 5%, suggesting that construction labor for the U.S. as a whole is critically short.” Shortages in workers with certain skills, such as electricians and steel-erection specialists, are particularly acute.

Indeed, the labor shortage has contributed to a leveling out of construction starts for new and existing home sales, and multifamily housing, through the first half of 2018. “The construction industry has been operating at full capacity and is still struggling to reduce its backlog of projects,” said Koropeckyj. The coming 12 months should experience a rebound as new multifamily building ebbs, releasing workers for the less labor-intensive single-family category.

All of the above factors seem to be inspiring business owners in general to echo consumers’ sense of optimism. Indeed, corporate profits are expected to rise by 3.7% in 2019, according to Moody’s. “We expect corporate profits to benefit from the tax reform mainly through the lower top tax rate and the new equipment accelerated expensing provision,” said Koropeckyj. “Also, a positive to corporate profits is the rollback of Dodd-Frank Act provisions, which had increased costs for businesses.” The anticipated level of business profits actually represents a deceleration from the 6.9% increase expected when 2018 numbers are tallied, a moderation largely due to an anticipated rise in labor costs and higher interest rates.

Clouds loom
Troubles do loom on the horizon. “The number one issue for retailers is the possibility of a trade war,” said Hoyt. “That would be a lose-lose situation, adding cost to imported merchandise and undermining job growth to some degree, therefore reducing spendable household income.” (However, Moody’s is not building much of a trade war into its 2019 forecast).

“The wild cards are tariffs,” said Phibbs. “If they really take place I think every retailer is worried. An average bike, for example, might go up $200 in price. Everyone is wait and see. It’s the monkey wrench that everyone is trying to figure out how to deal with. It will affect margins and ultimately consumers will pay for it.”

Businesses in general share retailers’ concern. “The major near-term concern for businesses is the rise of protectionist trade policies,” said Koropeckyj. “Escalating trade tensions between the U.S. and China could dampen investment more than expected. Company profits may be squeezed by the higher costs of imports. Not only could affected companies be hurt more than expected, but an erosion in business confidence due to heightened uncertainty would weigh on spending decisions.” The impact on business costs is moderated somewhat, she noted, by the strong dollar.

Here are some other potential problems peeking over the horizon, for businesses of all stripes:

* Rising interest rates. Higher costs of money pose a challenge for everyone, especially if the Federal Reserve raises rates too quickly. “Rising interest rates may not cause much impact in the short term,” said Tom Palisin, executive director of The Manufacturers' Assn., a York, Pa.-based regional employers' group with more than 370 member companies. “But later in 2019 the higher cost of money may start to constrict the availability of capital.”

* Wage hikes. Here’s the negative flip side of low unemployment. “With the economy chugging along as it is and unemployment lower, retailers may need to raise wages to attract enough people,” said Hoyt. That can crimp profits.

* A “hard Brexit.” If the U.K. fails to land a favorable deal with the European Union, an unmoderated departure can cause problems to the world economy. “We expect a Brexit deal to be reached at the last minute,” said Hoyt. “If it is not, it would be a negative for the global economy and U.S. consumers as supply chains and movement of workers would be disrupted.”

* Health care costs.  “On the cost side, health care is still a concern,” said Palisin. “Some 70% of our members report an increase in medical costs over the past year. Again, there is a lot of unpredictability in that sector. Will the Affordable Care Act continue? Be replaced? And will that result in higher costs? Employers don’t know where all this is going.”

Business cycle ages
To look a bit further down the track, there are signs that the fast-moving economic carriage may be nearing the top of the roller coaster. “The nation is experiencing robust economic growth, tightening labor and product markets, intensifying wage and price pressures, monetary tightening, and higher interest rates,” said Koropeckyj. “These characterize a business cycle nearing its end, just prior to a recession.”

When might that event occur? “We prefer not to forecast recessions, which are often caused by shocks that cannot be predicted,” said Koropeckyj. “However, our forecast for 2020 includes a set of conditions that are consistent with a recession. While we do not expect the textbook definition -- two quarters of GDP decline — to occur, real GDP growth is expected to slow to a crawl.” Other relevant predictions include a too-rapid increase in unemployment, the cessation of job growth, flat industrial production, and a deceleration of personal income growth.

To help draw a bead on the recession’s timing—or maybe just to bring into sharper focus the changing operating environment—Hoyt suggested watching a number of important indicators in the early months of 2019. “I would keep a close eye on the political environment,” said Hoyt. “What is going on with tariffs, and is there a risk of a trade war? Beyond that, I would watch for indications about the anticipated pace of interest rate hikes from the Federal Reserve. At some point those will start to bite and put a damper on growth. That will probably be an issue for later in 2019, but the faster rates go up the sooner the economy might be affected.”

For retailers, the employment picture may be the most important factor of all. “Watch for anything related to the labor market,” said Hoyt. “How much are wages accelerating, and is the increase fast enough to offset any deceleration of employment growth?”

For businesses of all kinds, the prudent course seems to involve capitalizing on good times while setting up Plan B for the inevitable correction. “Businesses are optimistic about 2019, but we are all aware that recessions are cyclical,” said Manzella. “And there is no doubt that the next recession is on its way. The only question is when.”