Posts tagged Us Macroeconomic Data
They say numbers don’t lie, right? So what to make of the 4.1 percent real growth rate in US gross domestic product (GDP) from the first to the second quarter of the year? We feel quite comfortable in predicting that the narrative of today’s news cycle will be anything but unified. Depending on what news source you turn to for a first take on today’s Bureau of Economic Analysis release, you may be told that this quarterly number is in fact the dawning of the Age of Aquarius, when peace will guide the planets and love will steer the stars (hi, kids! ask your parents…). Or, alternatively, that 4.1 percent really isn’t 4.1 percent at all, but a fictitious sugar high delivered on a transitory pile of soybeans, never to be seen again.
As usual, the reality is somewhere between delusional happy talk and delusional apocalypse-now talk. Here’s an actual picture of GDP growth over the full cycle of the economic recovery that began in the middle of 2009. We show both the quarter-to-quarter rate of growth and the somewhat smoother year-on-year growth trend.
Something Old, Something New
The best way, in our opinion, to interpret the current trend in GDP growth is to ascribe much of it to factors that have been underway for some time. Consumer spending is by far the largest single component of GDP, accounting for more than 70 percent of the total, and Americans have continued to not disappoint in their purchasing predilections. Fixed private sector investment – both residential and commercial – also reflects continuing confidence by homeowners and businesses alike. The mix will change in any given quarter – nonresidential construction and intellectual property investment were key drivers this quarter while residential investment declined – but the overall trend has stayed positive. This is the “something old” – a continuation of the modest but steady growth that has characterized recent years.
The “something new” shows up in an usual jump in US exports, which grew by 9.3 percent overall and which was dominated by certain categories of goods. Enter the “soybeans” meme. It appears that other countries have been stockpiling various products from the US which they expect to jump in price on account of the new tariff regime. Those bags and bags of soya beans from Iowa really were a second quarter phenomenon, were mostly related to China, and have mostly stopped with the implementation of the first wave of tariffs imposed by Beijing on US products earlier this month.
Looking beyond the quirks of any given quarter – and as the above chart shows, these numbers do bounce around considerably – the longer term question is how much of this growth is sustainable. The average annual rate of GDP growth since the second quarter of 2009 has been 2.4 percent. Many economists argue that even that number is too high – remember that for a good chunk of this time much of the growth came courtesy of direct monetary intervention by the Federal Reserve, which is no longer in effect. The fiscal stimulus put in place at the end of last year – windfall tax cuts to US businesses – may have the effect of elevating fixed investment above trend levels for a few more quarters, but that has the longer-term implications of significantly higher deficits and thus borrowing costs. This could be a particularly thorny problem if it converges with a sustained period of higher interest rates as the Fed tries to “normalize” borrowing rates.
There has not been much in the way of market reaction to today’s GDP release – partly because the number was largely in line with consensus estimates and thus already baked into stock prices. Investment sentiment around GDP appears largely dominated by the “something old” theme – different quarter, same trends – while ascribing little in the way of impactful news to either transitory short term phenomena like soya bean exports or the longer term borrowing implications of the fiscal stimulus. This way of looking at what is arguably the economy’s lead headline number also assumes that the trade tensions are mostly smoke and mirrors and will not metastasize into an all-out hot war (which view got some support this week with a surprisingly docile outcome of trade talks between the US and the EU).
What has some observers feeling blue, even when most data point to continued growth in the economy and with corporate sales and earnings, is that this recovery cycle is already long by historical standards. We have discussed this in other recent commentaries, usually with the caveat that every cycle is different and that recoveries don’t end because they pass some arbitrary calendar milestone. We do not think we are in for some super-long period of above-trend growth. Neither, however, do we see a compelling case for an imminent winding down of this cycle.
Stock prices rise and fall on account of all sorts of influencing factors on any given day. For the time being, at least, the overarching economic narrative does not give us much cause to be feeling blue.
The financial news headlines on this, the first Friday of the second half of 2018, seem fitting. Appropriately contradictory, one might say, providing a taste for what may lie ahead in these next six months. First, we have news that Donald Trump’s splendid little trade war is happening, for real now! Tariffs have been slapped on the first $34 billion worth of products imported from China. On the other side of the ledger, an American ship full of soya beans was steaming full-on to reach the Chinese port of Dalian in time to offload its supply before facing the retaliatory tariffs mandated from Beijing. Too bad, so sad, missed the deadline. Apparently the fate of the ship, the Peak Pegasus, was all the rage on Chinese social media. The trade war will be Twitterized.
The second headline today, of course, was another month of bang-up jobs numbers led by 213K worth of payroll gains (and upward revisions for prior months). Even the labor force participation rate, a more structural reading of labor market health, ticked up (more people coming back into the jobs pool is also why the headline unemployment rate nudged up a tad from 3.8 to 4.0 percent). Hourly wages, a closely followed metric as a sign of potential inflation, recorded another modest year-on-year gain of 2.7 percent.
So there it is: the economy continues to carry on in good health, much as before, but the trade war has moved from the theoretical periphery to the actual center. How is this going to play out in asset markets?
Manufacturers Feel the Pain
The products covered by this first round of $34 billion in tariffs are not the ones that tend to show up in Wal-Mart or Best Buy – so the practical impact of the trade war will not yet be fully felt on the US consumer. The products on this first list include mostly manufacturing components like industrial lathes, heating equipment, oil and gas drilling platform parts and harvester-thresher combines. If you look at that list and think “Hmm, I wonder how that affects companies like Caterpillar, John Deere and Boeing” – well, you can see for yourself by looking at the troubled performance of these companies’ shares in the stock market. As of today those components will cost US manufacturers 25 percent more than they did yesterday. That’s a lot of pressure on profit margins, not to mention the added expense of time and money in trying to figure out how to reconfigure supply chains and locate alternative vendor sources.
Consumers Up Next
The question – and probably one of the keys to whether this trade war inflicts real damage on risk asset portfolios – is whether the next slates of tariffs move from theoretical to actual. These are the lists that will affect you and me as consumers. In total, the US has drawn up lists amounting to $500 billion in tariffs for Chinese imports. In 2017 the US imported $505 billion from China – we’re basically talking about the sum total of everything with a “Made in China” label on it. Consumers will feel the pain.
If it comes to pass. The collective wisdom of investors today has not yet bought into the inevitability of an all-out trade war. US stocks are on track to notch decent gains for this first week of the second half. The job numbers seem to be holding the upper hand in terms of investor sentiment. Sell-side equity analysts have not made meaningful downward revisions to their sunny outlook for corporate sales and earnings. Sales for S&P 500 companies are expected to grow at a rate of 7.3 percent this year. That reflects an improved assessment from the 6.5 percent those same analysts were projecting three months ago – before the trade war heated up. The good times, apparently, can continue to roll.
Since we haven’t had a global trade war since the 1920s, we can’t model out just how these tariffs, in part or in full, will impact the global economy. Maybe the positive headline macro numbers, along with healthy corporate sales and profits, can power through this. Perhaps the trade war will turn out to be little more than a tempest in a teapot. We may be about to find out.
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.
History is simply a collection of the biographies of great people, the charismatic heroes and anti-heroes whose supreme self-confidence, fanatical drive and decisiveness write the chapters of the ages. So believed Thomas Carlyle, the 19th century Scottish philosopher and historian who penned works on Napoleon, Frederick II of Prussia and a “Great Man Theory of History” in general.
Or, history is actually not that at all. History enslaves all humankind, great and small alike, to bit-player roles in a complexity of events, near-events and non-events that evolve in ways unfathomable and inaccessible to simplistic storytelling. So believed the great Russian writer Tolstoy, who devoted over 1,000 pages to a novel, War and Peace, to make this point.
To read War and Peace is to read of the cacophony of random events, missed communications, uninformed decisions and human behavioral traps that ultimately shaped events like the battles of Austerlitz and Borodino – not the genius of Napoleon, nor the resolve of Tsar Alexander I, but those thousands of probable and improbable things that had nothing to do with the supposed destinies of great men. “The tsar” wrote Tolstoy “is but a slave to history.” Outcomes have as much to do with weird supply-line hiccups, melting ice on river crossings and rioting prisoners as they do with those bold commands from the top generals.
Tolstoians Under Fire
Investment markets have been in a decidedly Tolstoian frame of mind for several years now. This view aligns with an understanding of the global economy as its own inscrutable, constantly evolving sea of complexity wherein rulers of nations and titans of industry float and bob like tiny specks on the surface. Geopolitical flare-ups happen; currency crises spring up in the Eurozone, citizens vote in seemingly irrational ways, but the global economy just keeps on keeping on. Real GDP keeps growing, corporate earnings grow even faster, job markets and consumer prices reassure us that there are no nasty recessions lurking around the corner. This mindset reached its high point in 2017, when volatility reached historically low levels no matter how crazy, dire or improbable the news of the day.
But this Tolstoian view has run into some stiff headwinds among investors in early 2018. There seems to be a newfound sense, among many, that humans vested with considerable power can, in fact, make consequential decisions that directly impact the value of portfolios of risk assets. The specific catalyst bringing out investors’ inner Carlyle is the growing threat of a trade war. Thursday’s reversal of 2.5 percent on major benchmark indexes was driven in large part by the latest show of bellicosity by the Trump administration and threats of retaliation by China, currently the primary intended target of a new round of punitive tariffs. Investors who were hoping for a quick V-shaped recovery from the original sell-off a few weeks ago can blame that original announcement of new tariffs on aluminum and steel for cutting off the nascent recovery in share prices.
Great (by which we mean “vested with lots of power,” not to be confused with “good”) leaders making bad decisions: a Carlyle-esque reprise of that ill-fated summer of 1914? Or, ultimately, a brief tempest that sooner or later will fall back into an inconsequential ripple on the ever-expanding sea of the global economy? Your own view of markets in 2018 may well be shaped by whether you are more inclined to agree with Carlyle or with Tolstoy.
The Corporate America Variable
If Trump and his inner circle continue to raise the stakes on a trade war, they will be due for an earful from many corners of Corporate America for whom such an outcome is the very opposite of their business growth models. S&P 500 corporations derive in the aggregate more than half their revenues from outside the US. Almost any major company that produces a good or service with a viable market in China is focused on that market for a considerable amount of its potential future growth. This doesn’t just apply to the obvious names of retailers like Starbucks, Nike and Yum! Brands that have been in that market for years, but to firms in any industry from property & casualty insurance to pediatric nutrition to semiconductors. Sure, steel producers may cheer the prospects for protective tariffs in the short run, but their collective market cap weight is considerably less than that of those who forcefully champion more open trade.
So what will it be? Is the global economy, the creation of millions of random interactions of events and non-events and near-events over the past four decades, destined to simply keep evolving, too massive and too necessary in its current form for a sudden reversal into autarkic nation-states waging economic war on each other? Our general inclination is to take a Tolstoian view of things, and we think it likelier than not that the threat of $60 or even $100 billion in punitive tariffs and associated bellicose posturing will not have the power to topple a global economy worth more, in nominal GDP, than $85 trillion.
That is not to say that we have a Panglossian “best of all possible worlds” take on things. Tolstoy never said that history always works out for the best. Sometimes those random, incoherent things that happen or that don’t happen lead to unhappy outcomes – see 1914, 1917 and 1933 as examples of this in the last century. Disciplined investing requires keeping emotions in check, but it also requires us to not rule out improbable, but possible, scenarios.
Readers of a certain age might remember a perennial favorite among the many outstanding skits performed by late-night TV host Johnny Carson (hi, kids! – ask your parents or their parents). Playing a manic movie review host named Art Fern, Carson would suddenly display a spaghetti-like road map and start giving inane directions to somewhere, leading to the gag: “And then you come to – a fork in the road” at which moment he points to a space on the map where an actual, eating utensil-style fork is crudely taped over the incoherent network of roads. Ah, kinder, simpler, Twitter-less times, those were.
The fork in the road was a key theme of our annual outlook a couple months ago (no match for Art Fern in wit or delivery, but still…). Are we heading down one path towards above-trend growth powered by an inflationary catalyst, or another one characterized by the kind of below-trend, muted growth to which we have become accustomed in this recovery cycle thus far? For now, the data continue to point to the latter.
No Seventies Show, This
Carson’s heyday as host of the Tonight Show was in the 1970s, that era of cringe-worthy hairstyles, mirror balls and chronic stagflation. When the Bretton Woods framework of fixed currencies and a gold exchange standard fell apart in the early years of the decade it freed countries from their exchange rate constraints and encouraged massive monetary stimulation. The money supply in Britain, to cite one example, grew by 70 percent in 1972-73 alone. More money chasing the same amount of goods is the classic recipe for inflation, which is exactly what happened. OPEC poured flames on the fire when, as a geopolitical show of strength, it raised crude oil prices by a magnitude of five times in late 1973. A crushing global recession soon followed as industrial output and then employment went sharply into reverse, with countries unable to stimulate their way out of the mess caused by inflation.
A popular delusion in the immediate wake of the 2016 US presidential election was that some modern day variation of that early-70s stimulus bonanza was about to flood the economy with hyper-stimulated growth. Interest rates and consumer prices would soar as the new administration tossed out regulations, slashed taxes, lit a fire under massive public infrastructure and induced companies to kick their production facilities into high gear. The “reflation-infrastructure trade” flamed out a couple months into 2017 (though CNBC news hosts never got tired of hopefully invoking the shopworn “Trump trade is back!” mantra for months afterwards, every time financial or materials shares had a good day).
Herd-like investor tendencies aside, though, there was – and to an extent there continues to be – a case to make for the return of higher levels of inflation. Economies around the world are growing more or less in sync, which should push both output and prices higher. Taxes were indeed slashed – the one piece of the reflation trade puzzle that actually transpired – and as a result the consensus estimates for US corporate earnings have moved sharply higher. And yet, the numbers keep telling us something different.
Secular Stagnation Then, and Now
When we say “numbers” we refer generally to the flow of macroeconomic data about growth, production, consumption, labor, prices et al, but we’ve been paying particular attention to inflation. The core (excluding food and energy) Personal Consumption Expenditure (PCE) index, which is how the Fed gauges inflation, has been stuck around 1.5 percent for seemingly forever. This past Tuesday gave us a fresh reading on the core Consumer Price Index (CPI), the one more familiar to households, holding steady at 1.8 percent. We also got another lackluster reading on retail sales this week, suggesting that consumption (the largest driver of GDP growth) is not proceeding at red-hot levels. And last week’s jobs report showed only a modest pace of hourly wage gains despite a much larger than expected increase in payrolls. These numbers all seem to point, at least for now, towards the path of below-trend growth. Perhaps the bond market agrees with this assessment: the yield on the 10-year Treasury has been cooling its heels in a tight range between 2.8 – 2.9 percent for the past several weeks.
The economist Alvin Hansen coined the phrase “secular stagnation” back in the late 1930s, at a time when it seemed that long term growth lacked any catalyst to kick it in to a higher gear. We know what happened next. The war came along and rekindled productive output, followed by the three decades of Pax Americana when we ruled the roost while the rest of the world rebuilt itself from the ashes of destruction. Former Treasury Secretary Lawrence Summers brought the term “secular stagnation” back into popular use earlier in this recovery cycle. The numbers seem to tell us that this remains the default hypothesis.
But the story of the late 1930s reminds us that all a hypothesis needs to knock it off the “most likely” perch is the introduction of new variables and resulting new data. Foremost among those variables would be productivity (hopefully productivity from benign sources, and not from hot geopolitical conflict). It may well be that we have not yet arrived at that “fork in the road” but are still somewhere else on Art Fern’s indecipherable road map – and that a new productivity wave will pull us off the path of secular stagnation. The data, though, aren’t helping much in signaling when, where, and how that might happen.