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MV Weekly Market Flash: Baby Blues

May 18, 2018

By Masood Vojdani & Katrina Lamb, CFA

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We came across one interesting little data point this week amid the usual news avalanche. The US birthrate reached a 30 year low in 2017: fewer babies were born here last year than any year since 1987. What caught our eye was the odd timing. Birth rates tend to be loosely, but positively, correlated with economic growth (rising during good times and falling when growth goes south). 2017 was the eighth year of what is now the second longest economic expansion in US history. And yet…fewer babies. The fertility rate has fallen from 2.1 kids per woman of childbearing age a decade ago to 1.8 today.

The Growth Recipe

Population data like birth rates don’t typically figure in to short term market movements; we would feel confident in opining that these latest reports, which came out yesterday, did not figure into the day’s movements of the S&P 500 or the 10-year Treasury yield or the price of a barrel of Brent crude oil. But they do matter for the bigger picture, which is why every now and then they will show up in one of our weekly commentaries. Population growth is one part of the long term economic growth equation, along with labor force participation and productivity. Right now, all three of these variables are either negative or stagnant, which puts a big asterisk next to that longevity record for the current recovery. What good is an expansion if the rate of expansion is, by historical standards, so low? And while there may not be much we can do about broad population trends, what is it going to take to bring back higher productivity? The chart below shows the long term trends (since 1950) for productivity and labor force participation.

This is a useful chart for understanding what we mean when we talk about “long term growth.” There are two notable dynamics here. The first was the remarkable burst of productivity that came in the immediate postwar era. This was the heyday of Pax Americana, when our factories and the goods they produced were the envy of the world. As the chart shows, the average rate of productivity (the thin blue vertical columns) was substantially higher during this period than it has been at any time since. Productivity stared to decline in the early 1970s as the economy globalized and other nations – notably a rebuilt Germany and Japan – caught up.

But another trend kicked in around the same time that kept the growth going. This was labor force participation, represented in the chart by the green line. The baby boom generation started to enter the workforce, and so did women, heralding the arrival of the two income household as mainstream. Labor force participation went on a massive surge that didn’t crest until the late 1990s. Then, another productivity boom (though less impressive than that of the 1950s-60s) happened in the late 1990s and early 2000s, this one driven mostly by the delayed impact of information technology in the office and new business processes, like just-in-time inventory management and enterprise resource management, that made efficient use of all that new computational capacity.

Alexa, Make the Economy Grow

Which brings us to today. The decline in the labor force participation rate appears to have stabilized at a level close to that of the late 1970s, while productivity for the last decade is the lowest since record-keeping began in 1948. Imagine for a moment that you are looking at the above chart in 2030, twelve years from now. Or even farther down the road, in 2040. What will it look like?

As for labor force participation, we have some clues in those population trends we observed in the opening paragraph of this commentary; namely, the US population is ageing and the fertility rate is moving farther away from the replacement rate (where each new generation has enough children to replace the outgoing generation). We are not likely to see another phenomenon akin to the sudden surge of two-income households in the 1970s and 1980s to boost participation rates.

That leaves productivity as the only variable with potential energy. If our kids and their kids are looking at this chart and remarking on the great growth cycle of the 2020s, it will be due to a new wave of productivity that we have not yet seen but that may well be lurking under the surface. Artificial intelligence, immersion reality, quantum computing…these are technologies that are known but that have not yet shown themselves to translate to economic growth. But that may be simply a matter of time. The computer technologies developed in the vast mainframe labs of the mid-20th century didn’t flex their commercial muscles until much later, after all.

Or maybe our grandkids won’t care about this chart at all. “Economic growth” didn’t become the go-to proxy for “quality of life,” with all the attendant statistics like GDP, inflation and labor productivity, until after the Great Depression (which is why all the official records for these numbers didn’t start until the 1940s). Maybe some other metric will matter more to them…and to us, in our advanced years.

In the meantime, though, a healthy dose of productivity would be a nice antidote to those baby blues.

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MV Weekly Market Flash: Another Miss for Productivity

February 2, 2018

By Masood Vojdani & Katrina Lamb, CFA

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Longtime readers of our research and commentary know that we spend quite a bit of time dwelling on the economic metric of productivity. Our reason for that is straightforward: in the long run, productivity is the only way for an economy to grow in a way that improves living standards. Curiously, the quarterly report on productivity issued by the Bureau of Labor Statistics generally fails to grab the kind of headlines the financial media readily accord to unemployment, inflation or GDP growth. So there is an excellent chance that today’s release showing a drop of 0.1 percent in productivity growth for Q4 2017 (and a downward revision for the Q3 number) didn’t show up in your daily news digest. And while one quarter’s worth of data does not a trend make, the anemic Q4 reading fits in with a larger question that bedevils economists; namely, whether all the innovation bubbling around in the world’s high tech labs will ever percolate up to deliver a new wave of faster growth.

Diminishing Returns or Calm Before the Wave?

The chart below shows the growth rate of US productivity over the past twenty years. A burst of relatively high productivity in the late 1990s and early 2000s faded into mediocrity as the decade wore on. After the distortions (trough and recovery) of the 2007-09 recession, the subsequent pattern has for the most part even failed to live up to that mid-2000s mediocrity. 

 

There are two main schools of thought out there about why productivity growth has been so lackluster for the past 15 years. The first we could call the “secular stagnation” view, which is the idea that we have settled into a permanently lower rate of growth than that of the heyday of 25 years or so following the Second World War. The second school of thought is the “catch-up” argument, which says that scientific innovations need time before their charms fully work their way into the real economy. Readers of our annual market outlooks may recall that we closely examined the secular stagnation argument back in early 2016, while the catch-up philosophy occupies several pages of the 2018 outlook we published last week.

The most persuasive evidence made by the catch-up crowd is that both previous productivity waves – that of the late ‘90s – early 00s shown in the above chart and the longer “scale wave” that ran from the late 1940s to the late 1960s – happened years after the invention of the scientific innovations that powered them. Most economists ascribe a significant impact to the products of the Information Age – hardware, software and network communications – in explaining the late 1990s wave. But those products started to show up in business offices back in the early 1980s – it took time for them to make an actual impact. According to this logic, it should not be surprising that the potentially momentous implications of artificial intelligence, deep machine learning, quantum computing and the like have yet to show that they make a real difference when it comes to economic growth.

Productivity and Inflation

The economic implications of productivity tend to be longer term rather than immediate – that is probably why they don’t merit much coverage on the evening news when the BLS numbers come out. After all, the economy is not going to stop growing tomorrow; nor will millions of jobs disappear in one day if another productivity wave comes along with the potential to make all sorts of service sector jobs redundant (a point we make in our 2018 outlook if you’re interested). The lack of immediacy can make productivity debates seem more like armchair theory than like practical analysis.

But productivity (or its lack) does have a lot to do with a headline number very much in the front and center of the daily discourse: inflation. What the BLS is reporting in the chart above is labor productivity: in other words, the relationship between how much stuff the economy produces and how much it costs to pay for the labor that produces that stuff. If compensation (wages and salaries) goes up, while economic output goes up by a smaller amount, then effectively you have more money chasing fewer goods and services – which is also the textbook definition of inflation.

In fact, the BLS notes in its Q4 productivity release that higher compensation was indeed the driving factor behind this quarter’s lower productivity number. Bear in mind that unemployment is currently hovering around the 4 percent level (this is being written before the latest jobs report due out Friday morning), and anecdotal evidence of upward wage pressures is building. An upward trend in unit labor costs (the ratio between compensation and productivity) has the potential to catalyze inflationary pressures.

Keep all this in mind as we watch the 10-year Treasury inch ever closer towards 3 percent. As we noted in our annual outlook, it makes sense to watch the bond market to understand where stocks might be going. And anything related to inflation bears close monitoring to understand what might be happening in the bond market.

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MV Weekly Market Flash: Popular Data, Invisible Data

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It’s Jobs Friday, always a fun day for financial pundits as they craft ways to put a defining, click-friendly metaphor on the latest signal of health (or lack thereof) in the labor market. This month’s winning metaphor is that staple of kids’ birthday parties, the bouncy house. “US jobs growth bounces back” says the Financial Times. Adam Samson, the FT reporter whose byline is attached to that article, appears to be on the same cosmic wavelength as Patricia Cohen of the New York Times, whose lead headline today reads – wait for it – “U.S. Job Growth Bounces Back”. The style manuals of the FT and NYT – U.S. or US? Jobs plural or singular? Caps or no caps in the headline? – were on full display. Over at the Wall Street Journal they seem to have quietly retired the “Jobs Friday Live Blog” of times past, but the WSJ’s team of economists nonetheless has a massive “Everything You Need to Know” section on the April jobs report. Indeed, to the credit of those featured, that is one exhaustive parsing of the BLS release.

If Productivity Fell and Nobody Heard It, Did It Still Fall?

Not every macroeconomic headline gets the popular-kid treatment of the monthly BLS release, of course. Consider the financial headlines just yesterday, May the Fourth (insert nerdy Star Wars reference here). Yesterday was Productivity Thursday. Ha-ha, of course it wasn’t, because there was basically no coverage of the only economic data point that actually has the capability to deliver sustained growth. What did yesterday’s headlines focus on? Postmortem commentary on the FOMC’s meeting pointing to a June rate hike…the final pre-election debate between Macron and Le Pen over in France…the sausage makers on Capitol Hill hastily throwing together a gambit on the 18 percent of the US economy represented by health care. Important stories, all. Meanwhile, nonfarm labor productivity fell 0.6 percent for the first quarter, well below the consensus expectation of 0.1 percent and yet another lackluster contribution to a chronically underperforming long term trend.

Stop Us If You’ve Heard This One Before

Everyone talks about growth; the notion that the economy will be stronger in the future than it is today is literally the single animating notion behind the capitalist impulse to defer the benefits of a dollar today for the payoff of that dollar’s growth over a defined period of time. But talking about growth without focusing on productivity is like talking about why you just came down with a nasty cold without considering the fact that you recently went out for a walk in the snow barefoot, in shorts and a t-shirt. That is what makes the absence of Productivity Thursday so conspicuous, and why the obsessive focus on monthly payroll gains appears so misplaced.

If anything, the leading number of Jobs Friday should be the labor force participation rate. That nudged down to 62.9 percent from last month’s 63 percent. It remains far below the peak of more than 67 percent reached at the end of the 1990s. Why is this number important? All together now…long term growth is a function of three variables: overall population growth, growth in the number of people working as a percentage of total population, and productivity (how much gets produced for every hour of effort invested).

For most of human history the only variable that mattered was population growth. If that were still true, we would have to content ourselves with annual GDP growth around 0.7 percent, which happens to be the most recent annual rate of population growth. We have little reason to believe that labor force participation is going to improve anytime soon: both demographics and job-replacing technology will see to that. Which leaves productivity, and which is why Productivity Thursday deserves its rightful place at the cool table in the cafeteria of macroeconomic data. Yes, those payroll numbers are useful. But with the unemployment rate at 4.4 percent one might wonder why participation remains stagnant and wage growth is still relatively subdued. Productivity Thursday could help shed some light here.

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MV Weekly Market Flash: GDP Matters, Productivity Matters More

January 27, 2017

By Masood Vojdani & Katrina Lamb, CFA

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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.

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MV Weekly Market Flash: Return of the Dot-Plotters

December 16, 2016

By Masood Vojdani & Katrina Lamb, CFA

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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.

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