In ’09 and ’10, when Mohammed El-Erian and Bill Gross both worked at PIMCO, they put forth a concept they called “the New Normal.” It postulated that the economy would grow at a much slower rate than it had in the past, and therefore market returns – both equity and fixed income – would be much lower than what we had experienced in the post-WWII era. Nice theory, many thought; but equity market returns, at least from the lows in ’09 through the middle of ’14, were near 14 percent annually, trailing off to just over 7 percent from the middle of ’14 to the middle of ’15. The last year, however, saw the equity market struggle. And with equites still richly priced, returns in bondland microscopic, little verve in the U.S.’s macroeconomic outlook, and even less throughout the world, perhaps we have now truly entered New Normal conditions.
In his June 2 blog entitled “Bon Appetit!,” Gross (now at Janus) neatly sums up the New Normal: “For over 40 years, asset returns and asset generation,” he said, has “been materially aided by declines in interest rates, trade globalization, and an enormous expansion of credit – that is debt. Those trends are coming to an end, if only because, in some cases they can go no further … A repeat performance [of post-WWII economic growth and market returns] is not only unlikely, it is impossible …”
To flesh this out, consider the following:
- Interest rates, now experimenting with negative levels, can hardly go down further;
- The Fed appears to have painted itself into an ugly corner; it clearly wants to begin the rate “normalization” process (i.e., higher rates) and communicated that to the market, but the rest of the world’s central banks are still frantically easing, and any rate increase in the U.S. only serves to have a negative impact on U.S. manufacturing exports via a stronger dollar;
- Trade globalization is now ending with something akin to currency wars and responses via government tariff actions, the latest being U.S. imposition of tariffs on steel imports from China;
- Government debt throughout the world has skyrocketed with corporate debt right behind. Luckily, at least so far, consumer balance sheets have not succumbed (student debt being the significant exception). Of course, as long as the world’s central banks continue to print money and buy government debt (and now the European Central Bank is even buying private sector corporate debt), it appears that we are not yet at the end of the debt growth cycle (bubble?)
The latest data
With the May official employment report showing employment growth of a mere 38,000 (and a negative 59,000 revision to the March and April data), the threatened Fed rate hike in the June/July time frame has probably been taken off the table. Continued weakness in the employment data, which seems likely from the latest business surveys and regional Fed economic reports, may keep them on the sidelines for the foreseeable future.
The Conference Board’s Consumer Confidence Index fell to a six-month low at 92.6 vs. 94.7 in April. The ISM Manufacturing Index (a dispersion index) did rise to 51.3 in May from 50.8 in April, but that was mostly technical in nature. All of the regional Fed manufacturing indexes were weak in May, suggesting that the national ISM Manufacturing Index will slide into contraction in June. And the ISM Non-Manufacturing Index fell from 55.7 in April to 52.9 in May.
On the more positive side, May’s auto sales data came in higher than expected at a 17.4 million unit annual rate (vs. 17.3 million for April). Of crucial significance, the Atlanta Fed’s “GDP Now” model (which has proven to be quite accurate over the past few quarters) is pointing to a 2.5% GDP growth for Q2.
Still no recession in sight
I keep reading that the gasoline savings are not being spent, and that is the cause of the economic sluggishness. I don’t buy it.
- Memorial Day weekend set a record in the U.S. for miles driven;
- Restaurant sales continue to rise;
- Travel and vacation spending at hotels and airlines are rising; load capacity on U.S. airlines has been near record levels, and considering the wait times to get through security over the Memorial Day weekend, it appears that airline load factors have risen further;
- Theme parks are also seeing record attendance.
So it would appear that the gasoline savings are being spent and there is no recession in sight (but the weakness in employment is worrisome). The sluggishness in the consumption data (retail sales, etc.) is partly the result of demographics. As all retirees have done before them, the retiring baby boom generation (the largest demographic cohort and the one with most wealth) reduce their marginal propensity to consume when they retire. But in today’s world with 0 percent returns, their MPC has fallen further, as they fear their retirement nest eggs won’t last for the remainder of their lives. Thus, the unexpected (at least at this stage of the business cycle) and seemingly odd rise in the savings rate. Japan has this problem in spades. Europe too. It is part of the New Normal. Dealing with it begins with “recognition” on the part of policymakers and their economic advisers, something we’ve yet to see.