Posts tagged Us Labor Productivity
It would appear that a lesson in US civics might be in order for Mr. Market. Investors breathlessly followed the staccato blast of tweets and executive orders emanating from Week One at the White House, rekindling the reflation-infrastructure trade that had seemed, tentatively, to be starting to take off the rose-tinted glasses. An executive order does not an actual implemented policy make, and the vaunted sausage-making process of legislative accomplishment continues to be at odds with the market’s bobby-sox crush on all things Trump administration.
Meanwhile in the world of actual data, this morning we got a preliminary reading on Q4 real GDP growth. The headline number came in a bit below consensus: the quarter-on-quarter increase of 1.9 percent was about 30 basis points below expectations. That translates to an annual average growth rate of 1.6 percent, making 2016 the lowest-growth year since 2011. How do the latest data affect expectations for next year and beyond? We look at both the near-term implications and what we see as the longer-term growth headwinds fiscal stimulus will not likely solve.
Buy Now, Pay Later
The overall consensus of economist views on the US economy in the coming 1-2 years has ticked up measurably since the election. Not to the levels of four percent real growth promised on the White House website (or the credulous investor herds who appear to agree), but increasingly closer to three percent than two. Much of the incremental growth, according to the new consensus, would start to show up in the latter half of 2017 and more fully in 2018. It would be premised on the realization of at least some form of the fiscal stimulus measures being tossed around, most directly corporate tax reform and new infrastructure spending. Most economists, when asked, stress that the nature of uncertainty around any of these measures or their timing adds a level of uncertainty to their outlook. And many are careful to add that successful implementation of these policies in the short run could have deleterious knock-on effects, as higher trade and budget deficits accompanied by higher than expected inflation could likely push up interest rates and the US dollar, making exports less competitive and thus detracting from growth. There are indeed many moving parts to the growth equation, which is why we habitually argue for caution against reading too much optimism – or pessimism for that matter – into likely scenarios for any given set of policies.
All that Matters
Ultimately, though, what long-term investors should care about, more than whether fiscal stimulus measure X gets implemented and causes interest rates to do Y and the dollar to do Z, is whether economic productivity will ever get back on track. GDP growth is important, but ultimately the growth comes from only three sources: population growth, an increase in the percentage of the population in the labor force, or productivity (the ability to produce more goods and services for each hour of effort and cost). Forget about the first two. Population growth is anemic: 1.2 percent per year for the world and just 0.8 percent per year for the US. Meanwhile the labor force participation rate, which reached a peak of about 68 percent at the beginning of the 21st century, has slumped to less than 63 percent for a variety of structural and cyclical reasons (more retirees, lingering effects of the recession etc.).
That leaves productivity. Unfortunately, there’s not much good news here either. Average output per hour, the standard measure of productivity, was lower for the last ten years than it has been for any ten year period since 1950. The current calendar decade thus far has been even worse: the 0.72 percent average annual growth rate for the period since 2010 is only one quarter of the rate for the 1960s, the most productive decade to date.
Opinions vary on why this is so, from the “best growth is behind us” view of the likes of Robert Gordon (author of “The Rise and Fall of American Growth”) to techno-optimists like Thomas Friedman of the New York Times who imagine that the true value-creating capabilities of more recent innovations have yet to bake themselves into macroeconomic statistics (Friedman ascribes 2007 – the year the iPhone was introduced – as a pivotal year in world history sine qua non). A separate but likewise relevant question is whether a new bout of technology-inspired productivity, particularly if it were to come from the gains in robotics brought about by deep-learning methods of artificial intelligence, might be severely counterproductive in its effect on the labor market. Again – lots of moving parts to consider in the complex adaptive system that is our economy.
Now, a genuine burst of real productivity (of the non-job killing ilk) could potentially smooth out the rough edges of the fiscal overheating that would be the likely outcome of the kind of programs this administration appears to want to implement. That is, of course, if the protectionist dark side of these programs were, at the same time, to not materialize. All those things combined could be a recipe for sustainable growth. But we will need to see far more evidence that any of them are likely to transpire before we think about joining the growth bandwagon.
Fiscal policy is where all the cool kids hang out now, as we noted in last week’s commentary. But the monetary policy nerds at the Fed got at least a modicum of attention this week as the dots settled on the Fed funds plot chart Wednesday afternoon. As was widely expected, the meeting resulted in a 0.25 percent target rate hike and some meaningful, if subtle, changes to the 2017 outlook. Three policy actions are on tap for next year, and this time the market seems to take this outlook seriously. Chair Yellen & Co. expect the recently favorable trends in output growth and employment to continue, while expecting to see headline prices reach the two percent target by 2018. These observations appear to be largely irrespective of what does or does not happen with all the hyped-up fiscal policy that has been driving markets of late. Be well advised: monetary policy will still matter, quite a bit, in 2017. It will have an impact on many things, not least of which will be the opportunity set of fiscal policy choices.
Divergent Today, Insurgent Tomorrow
Market watchers on Wednesday made much of the (temporary, as it turns out) pullback in stock indexes in post-FOMC trading. But the real action, as has often been the case in the last six weeks, was in the bond market. The yield spike is noteworthy in absolute terms, but even more striking on a relative basis. Consider the chart below, showing the spread between the 2-year U.S. Treasury note and its German Bund counterpart.
Short-term U.S. rates are at 52-week highs while German rates are at their 2016 lows. The spread between the two is wider, at 2.07 percent, than it has been at any time since 2003. Remember divergence? That was the big theme in the discourse one year ago, when the Fed followed through on its 2015 policy action last December. The Eurozone and Bank of Japan were full steam ahead with their respective stimulus programs as the Fed prepared to zag in the other direction. Then markets hit a speed bump in January, the Fed backed off any further action and rates came back down. As the above chart shows, U.S. and German short-term rates followed a more or less similar trajectory for most of the year.
But divergence is back with vengeance. Holders of U.S. dollar-denominated assets will be pleased, as the euro gets pushed ever closer to parity. Policy divergence leads to dollar insurgence. On the negative side, that insurgence looks set to redouble the FX headwinds that have clipped corporate top line revenue growth for much of the past two years. That, in turn, will make it challenging to achieve the kind of double-digit earnings growth investors are banking on to justify another couple laps of the bull market.
Three Times the Charm?
What we took away from Chair Yellen’s post-meeting press conference was a sense that the Fed’s world view has changed only modestly amid all the hoopla of the post-election environment. She took pains to note that the outlook shift to three possible rate changes in 2017 does not reflect a seismic change in thinking among the dot-plotters, but an incremental shift reflecting a somewhat more positive take on the latest growth, employment and price data.
And fiscal policy? Yellen could hardly avoid the topic; it was the point of the vast majority of the questions she fielded from the press. Over the course of her tenure at the Fed she has spoken many times of the need for monetary and fiscal policy to complement each other at appropriate times in the business cycle. This, however, may not be one of those times. Consider her comment in response to one question: “So I would say at this point that fiscal policy is not obviously needed to help get us back to full employment.” For the moment, at least, and in the absence of any tangible data to suggest otherwise, the Fed does not appear to be giving undue attention to the fiscal variable.
As Location Is To Real Estate, Productivity Is to Growth
Chair Yellen did make a point of emphasizing what kind of fiscal policy she does like: namely, that which directly helps boost productivity. That’s a point you have heard us make in this space ad nauseum, so it was good to hear it from the Eccles Building. What kind of fiscal policy could that be? Education, jobs and skills training programs and improving the quality of installed capital used by American workers were specifically called out by the Fed chair. Of course, there is no clarity of any kind that such productivity-friendly programs will make it through the legislative sausage factory. One can always hope, though.
The most contentious U.S. presidential election in modern history is approaching its dramatic conclusion, and the media discourse is saturated with breathless prognostications of doom and gloom. Even the stock market has gotten in on the act, with the S&P 500 retreating eight days in a row and flirting with a 5 percent pullback from the record high of 2190 set way back in the middle of August. Trumpkins and Clintonistas alike (not to mention “Pox on Both Houses” malcontents) see a Dark Ages v2.0 on tap if their candidate fails to snag 270 Electoral College votes next Tuesday. Strange times, these.
The Devil’s in the Data
And then there are the data. Actual numbers, lovingly compiled by earnest toilers at the Bureau of Labor Statistics and the Bureau of Economic Analysis and various other Bureaux in our fair land, reflecting how the economy is doing through the prism of job creation, price trends, consumer habits and much else. These numbers have painted a fairly consistent picture for the past couple years: moderate but below-trend growth, a weak recovery in wages and prices, stable spending patterns and improving consumer confidence. One important trend that appears to be solidifying is that of real wage growth.
Below today’s headline jobs number of 161,000 new payroll gains (which itself is notable in extending the post-Second World War record number of consecutive monthly jobs gains) is the 2.8 percent year-on-year growth in average hourly wages. This is not an outlier; wage growth in recent months has consistently outpaced inflation, whether measured by headline or core (ex food & energy) CPI or by the Fed’s preferred Personal Consumption Expenditures (currently 1.7 percent).
Real wage growth indicates that, after all those months of falling unemployment and new payroll gains, the labor market is tightening along the lines of historical norms. Those gains should help push consumer prices further towards the 2 percent target rate as a higher chunk of household earnings finds its way into spending on staple and discretionary goods and services. That, in turn, should be good news for GDP, about 70 percent of which derives from consumer spending. This is the virtuous circle that has driven past periods of economic growth.
One Cheer for Productivity
Sustained economic growth, as we never tire of pointing out, derives from growth in the overall population, or from an increase in the percentage of the population at work, or from improved productivity per average hour worked. That third option is critical, and economists have been puzzled by the chronic recent failure of the economy to achieve meaningful gains in productivity. In fact, productivity as measured by the BLS had decreased for three consecutive quarters leading up to the release this past Thursday (given the importance of this metric to overall growth, why is there no celebrated Productivity Thursday, along the lines of the popular Jobs Friday nerdfest?).
In any case, Q3 productivity surprised to the upside, growing 3.1 percent against expectations of 1.7 percent. That’s good! But of course it is only one quarter, so too early to break out the Veuve Cliquot. The other good thing about productivity, though, is that productivity gains help businesses leverage their operational expenses, including labor expenses. Improving productivity, all else being equal, should enable businesses to accommodate wage increases (see above) while maintaining or even improving profit margins.
Connecting the Dots from Macro to Earnings
Maintaining those profit margins will be extremely important for businesses as they try to work themselves out of the recent funk in corporate earnings. Average earnings had fallen for five consecutive quarters heading into the current (3Q16) earnings season. With about 85 percent of S&P 500 companies reporting, it appears the negative streak will come to an end: expectations now are for 2.6 percent EPS growth, as opposed to the minus 2.6 percent expected at the beginning of the quarter. That’s all well and good, but investors are keen to see a return to the double-digit earnings growth environment of years past. Productivity gains will need to continue to offset the effects of a tighter labor market.
Meanwhile, the headwind effect of the U.S. dollar should be expected to continue if, as likely, the Fed goes ahead with a resumption of its rate hike program come December. And while the virtuous cycle of stronger demand may take root here at home, there are still too many pockets of weakness and uncertainty in other geographic markets where large U.S. companies manufacture and sell. In short: an improved U.S. economy won’t be of much help to domestic share prices unless the dots between macro and earnings can be connected.
The Human Effect
Our optimism will thus remain guarded until we see more evidence of an improved economy having a measurable impact on business performance. Which brings us back to the topic that opened this commentary – the upcoming election. Is there any substance to those abundant prophesies of the imminent apocalypse? Or, in other words, how much actual damage could politicians create to choke off any nascent improvement in our little economic garden?
We must, of course, be cognizant of the profound dissatisfaction registered by many voices – not just here at home but around the world – against political structures and other perceived elite institutions. The dissatisfaction certainly influences the policy discourse and shapes how political leaders present themselves and their policy intentions. But we remain of the view that, regardless of what configuration of Democrats and Republicans win their races next Tuesday, the more extreme elements of their platforms will have a very hard time finding their way into actual law.
History has shown that ill-conceived human intervention can have a real, long-term negative impact on a society’s standard of living. History also shows, though, that revolutions don’t happen far more often than they do happen. We may live in strange times, but we do not see them as strange to the extent of Petrograd 1917 or Paris 1789. Until we have reason to think otherwise, we remain guardedly optimistic.
It has been called the window into the soul of the modern economy; the headline macroeconomic data point against which all others are measured. Many claim that Gross Domestic Product fails to capture a large part of what actually constitutes progress in the living standards of human beings around the world, yet there are as of yet no widely accepted methodologies for a more comprehensive measure. So the brainchild of economist Simon Kuznets, GDP’s founding father back in the dark days of 1937, remains our best proxy for the contribution of individuals, businesses and government entities to our economic well-being. All this by way of saying that today’s third quarter GDP release (preliminary) showed a pleasing upside turn after a disappointing first half of 2016. While the quarterly 2.9 percent spurt gives further support to the likelihood of a December Fed funds rate hike, though, today’s report sheds little light on the continuing mystery of where all the growth has gone.
The Trend Is Not Your Friend
Quarterly GDP releases are subject to considerable variance as they go through the iterative process of revisions before the final number is etched into the record books. We focus instead on the bigger picture: how strong is economic growth today, more than six years into the current economic recovery, relative to where it has been at a similar point in previous recovery cycles? The chart below shows year-on-year GDP growth for each quarter (for example, 3Q2016 compared to 3Q2015) from 1950 to the present.
In this context, the most remarkable thing about the current (2009 – present) recovery is that it has only once even grazed the long term real growth average for the past sixty six years of 3.25 percent. In other words, the current growth trend is far and away the weakest of any recovery cycle in the post-World War II economy. Now, this recovery came off the worst economic downturn since the Great Depression. But compare the rate of recovery in the first post-recession years of 2009-10 to that of 1983-84. Then, after the wrenching double-dip recession that spanned 1980-82, year-on-year GDP growth rates ran in the high single digits before settling down to a comfortable trend rate in the four to five percent range. The booming economy of the 1990s was characterized by fewer extreme outliers, but a consistent run rate above the long term average. But growth in the 21st century, thus far, bears little resemblance to its 20th century counterpart.
The Mystery Lies Not in GDP
The long term growth mystery is not why GDP has been so persistently low. That is relatively easy to answer. Economic output – which is what GDP measures – is a fairly simple formulation: the aggregate number of hours employed by working hands to produce things, and the value of things those hands can produce for each hour worked. That formulation, in turn, depends on just three things: (a) growth in the overall population; (b) growth in the percentage of the population employed in the labor force; and (c) the productivity of the labor force.
For example, a significant contributing factor to the strong GDP growth of the 1980s was the rise of labor force participation as a percentage of total population. That trend was driven primarily by the large scale entry of women into the full-time work force – a one-off growth phenomenon that peaked in the early 1990s.
By contrast, the underlying driver of growth in the booming 1990s was a resurgence of productivity, as earlier technological innovations facilitated the ability for workers to produce more in each hour worked than they had before. This was partly due to the delayed impact of 1970s-era technologies like personal computers, and partly due to business process innovations like supply chain optimization and integrated enterprise resource planning.
Productivity, Where Art Thou?
The mystery underlying today’s anemic growth rate is all about productivity; specifically, why it is not only below trend but has actually been negative for much of the recent recovery period. The chart below shows the thirty year trend in labor productivity alongside the concurrent decline in the labor force participation rate.
This decline in labor force participation and chronically low productivity are all we need to know to understand why GDP remains so persistently below trend – and why periodic upside surprises like today’s Q3 release don’t shed much light on the bigger picture. One quarter of brisk goods exports and business investment in structures – the catalysts for today’s outperformance – does not a sustainable growth trend make. What we do not know – the mystery in other words – is if and when any of the innovations of the past decade will show up in the form of higher productivity. The answer to that riddle will likely determine whether GDP ever finds its way back to those brisker 20th century norms.
The third quarter number – with whatever revisions happen between now and then – will be the most recent growth data point for the Fed to consider when they weigh the prospect of a rate hike in December. Assuming no negative surprises between now and then – either surprises from other headline macroeconomic numbers or a major pullback in risk asset markets – odds are good they will go ahead with a 0.25% move. We believe that will be the right thing to do. But this larger growth question will persist beyond December and will, in our opinion, be a major factor at play in shaping market performance in 2017.
Picasso’s 1932 painting “Girl Before a Mirror” is, like most of the artist’s work, open to wide and contentious speculation about “what it all means,” and in that sense it bears a likeness to today’s jobs report. Does the weak headline payroll number suggest an economy confronting its own dark mortality, like (perhaps) the girl in the painting? Put three art majors in front of the painting and you’re likely to get five opinions. The same appears to be true for economists as they look at the various discordant bits of the BLS report and try to piece it all together.
You have that bad payroll number (and downward revisions to previous months) alongside the best unemployment rate figure in nine years. There are meaningful improvements in the number of long-term unemployed, but the labor participation rate also fell for the second month in a row. Wages continue to make steady gains and remain ahead of both core and headline inflation – but shouldn’t wage growth be even higher at this stage of a recovery? The payroll numbers were impacted by a labor strike at Verizon, but that was not a big enough impact to offset the actual number falling more than 100,000 jobs short of consensus expectations. What is this disjointed picture trying to tell us? Or are we, like so many art critics, simply overthinking the importance and meaning of one single report?
A Bit More Pain with the Gains
What we can say for sure is that, almost halfway through 2016, the pace of payroll gains is weaker than it was for the past couple years. It was the rare month in 2014 and 2015 that failed to serve up at least 200,000 new jobs. When the number did fall short, stock indexes either rallied (Fed’s not going to raise rates!) or plunged (economy’s getting worse!) depending on what side of the bed Mr. Market woke up that morning. The average for the past three months, including the downward revisions to April and March, is 116,000. So the benchmark has come down. Even so, though, the current environment for jobs creation looks strong compared to the previous recovery in 2003-07, as shown in the chart below.
Not only is the current recovery the longest uninterrupted streak of positive jobs creation since the BLS started keeping records but, as shown in the chart above, the number of months with 200,000 jobs or more is higher and more consistent than it was in 2003-07. It may be natural, after such a long winning streak, for the pace to slacken off a bit. If the economy can manage to sustain a pace of more than 100,000 monthly payroll gains and continued steady wage improvement for at least another year or more, that would likely count as a win. For now, anyway, signs of a recession do not seem to be anywhere on the horizon.
However one chooses to interpret the payroll number, the labor participation rate leaves less room for creative opinionating. After showing some long-awaited signs of life in the first quarter of the year, the participation rate has fallen back down to 62.6 percent, just 0.2 percent above the decades-long low reached in September last year. Given that a lower participation rate means fewer people out actually looking for work, this trend also throws a bit of a wet blanket on that headline 4.7 percent unemployment rate. Remember that economic growth only happens when more people work or when more stuff gets produced for each hour of labor. With both the labor participation rate and the productivity rate in what appears to be a secular stagnation, the long-term growth question remains a mystery.
Of course, the conversation today and in the run-up to the next FOMC meeting in just 11 days will focus on what today’s numbers mean for interest rates. Our guess is that they mean very little. The Fed is likely more focused on the latest Brexit poll numbers than anything else as far as June is concerned, given their possible effect (however short term) on the all-important asset markets. There will then be a whole new batch of price, growth and jobs data to consider before July rolls around. Maybe it really is best to think of today’s jobs report as a Picasso painting – you can interpret it however you want, and your interpretation has no practical consequences in the real world.