From an investor’s standpoint, this has surely been a summer of discontent. All markets appear to be too high, there is no yield to be found, and there appears to be no place to hide, at least inside current investment standards as set forth by Wall Street. While the conventional wisdom looks at cash as “trash” because it generates no return, in today’s world where there is more deflation than inflation, cash may not be such a bad idea – even if you put it in your mattress.
Uncertainty
The economic picture is mixed, at best:
- Corporate profits are in a recession; they have been for several quarters, yet, because of the quest for yield (via dividends), stock prices continue at or near record highs;
- GDP’s growth rate for the past 3 quarters has been anemic (Q4:+0.9%, Q1:+0.8%, Q2:+1.1%), enough to make some pundits call for a recession in the next couple of quarters;
- Nevertheless, it is hard to forecast an oncoming recession when the unemployment rate is under 5% (August = 4.9%), job growth continues at a healthy clip (August = 151,000 albeit expectations were for 180,000), and consumption is rising at a rate of 4%+ (the models that use current data to track and forecast GDP are indicating 3.5%+ GDP growth rate for Q3). Employers are holding on to their employees as new data show that the rate of discharges is at the lowest level ever since such data has been kept (December, 2000);
- Even if you don’t believe the official BLS employment growth numbers because of the distortions due to seasonal manipulations and other assumptions (guesses), ADP, the largest payroll company in the U.S., has computed consistent job growth (near 180,000) over the past few months based on real payroll data; they showed employment growth at 171,000 in August;
- Still, the most distressing economic data points are the ones that indicate the structural headwinds that lie ahead – demographics and falling productivity – issues that won’t cause an immediate recession, but have a huge impact on future economic growth and investment decisionmaking.
The Absolute Level of Growth
Nearly every economic number is judged to be good or bad based on its absolute level of growth. The GDP is an obvious one, but think about other numbers like housing starts, auto sales, or total corporate profits. If they aren’t growing, something must be wrong. It is intuitive that the majority of economic growth comes from a growing population. (In 1915, the U.S. population was about 100 million; today it is in excess of 320 million.) And, it isn’t any wonder why there is an emphasis on absolute growth – Wall Street and business interests crave such growth because that is how paper wealth is created. That is, in the long-run, the DJIA, NASDAQ, and S&P 500 indexes ultimately require top line revenue growth to fuel profits and the general level of stock prices. Without such revenue growth, passive investment strategies, the ones relied on by most investors, don’t work. In a slow growth world, an investor must be able to pick companies that are actually growing in order to have their investment portfolios appreciate in value.
Declining Labor Force Means Declining Growth
In economies where the demographic structures are such that labor forces are shrinking, then, absent a high level of productivity growth, the number of units of goods and services is also going to shrink. Japan is today’s poster child for this. The labor force there is shrinking and that economy is doing poorly despite “experimental” monetary policies. In the U.S., the rate of labor force growth was 2.6%/year in the 1970s. It shrank to 1.0%/year in the 2000-2015 period, and is forecast by the Census Bureau to fall to 0.2%/year in the 2015-2025 period. A similar trend exists in every major industrial economy. So, unless immigration from third world nations is allowed to grow each industrial nations’ labor force, a really hot potato in the world’s politics today, economic growth in the industrial economies is going to slow significantly over the long-term horizon. As a result, the most important measure of an economy’s health is its labor force’s productivity growth. Even if that labor force is stagnant, or shrinking, if productivity is rising, it means that there is a healthy level of innovation, and that new investment and technology is being deployed.
Over the past few years in the U.S., fiscal policies have discouraged productivity growth (productivity has fallen in 5 of the last 7 quarters). Current corporate tax policy discourages investment in new (more modern) plant and equipment, and, the explosion of new and burdensome regulations discourages the formation or expansion of small businesses.
Conclusions
- While there is no recession in sight, we are currently in transition to a much slower growth economy;
- Today’s actual and potential policymakers have yet to come to grips with appropriate policies for a slow or no growth economy;
- For investors, the days of index investing are coming to an end. In markets that are growing slowly, not at all, or even negatively, active stock picking will be critical for investment success. Today’s conventional asset allocation model, where general economic growth rescues all portfolios, isn’t going to work in the slower-growth future;
- In an economy undergoing such transitions, cash may not be such a bad idea.
