Coaxing an Old Expansion into Stronger Growth
In the week ahead, as has been the case in every week since the election, investor attention will be divided between assessing current market fundamentals and speculating on how policies from the incoming administration could change them.
On the first issue, last week’s jobs report was generally positive. Payroll gains were a healthy 156,000 and, although the overall unemployment rate edged up to 4.7%, following a sharp decline in the prior month, the U-6 unemployment rate fell to its lowest level since April of 2008. With wage growth picking up, the economy is essentially at full employment.
Numbers due out this week should generally confirm this picture. Tuesday’s Job Openings and Labor Turnover report should still more than 5,000,000 job openings while Unemployment Claims should continue to run under 300,000 per week. In addition, the Retail Sales report for December should show that consumers spent heavily last month, although gains for autos, gas stations and on line, look a lot stronger than chain-store activity. These numbers should also help narrow estimates of fourth-quarter GDP.
It should, however, be noted that these estimates should still only show real GDP growth of between 1.5% and 2.0%, payback for a 3.5% surge in the prior quarter. While the U.S. economy remains healthy, it has shown no meaningful acceleration in recent months.
In addition, even though the economy is at full employment, its journey here has been deeply disappointing. Over the past decade the economy has eked out just 1.3% annual real GDP growth, only half a percent more than annualized population growth over the same period and far short of a pace that would provide any meaningful increase in living standards to the average American.
In many ways, of course, it is this slow growth that fueled the success of populist movements in 2016 and the election of the new President. But can the new administration’s policies improve this?
The answer to this is a qualified yes. The qualification is, that in order to achieve stronger growth, the government will have to pursue policies that both boost the number of people employed and the growth in labor productivity, and avoid policies that would impede either.
On the first issue, encouraging workers to retire later and rehabilitating those with addiction issues or felony convictions could boost the labor force. However, it would also seem sensible to increase the number of legal immigrants or work visas also since the retirement of the baby boom is leaving the U.S. with a virtually stagnant working age population. It must be admitted that there have been no signals of steps in this direction from the incoming administration. However, American business is well represented in the new government and could well nudge Washington policy in this direction.
The new administration is likely to push for policies that could strengthen labor productivity. Indeed, stronger productivity growth could be fostered just by boosting investment spending, which could, in turn, be triggered by reducing regulations and implementing a corporate tax cut, particularly one which encouraged the immediate repatriation of corporate cash held overseas.
However, it will be important for Washington to avoid steps that could undermine a pro-growth agenda.
–First, any trade war would likely reduce capital spending as companies won’t want to invest more in the U.S. if they are not sure about their access to foreign markets. In addition, higher tariffs would boost U.S. inflation, potentially triggering a more hawkish stance by the Federal Reserve.
–Second, any reduction in legal immigration could cause a problem as the United States is already chronically short of qualified workers.
–Third, any big surge in government spending on defense or public infrastructure or any big reduction in personal taxes could overheat the economy and prompt the Fed to adopt a more aggressive stance, boosting interest rates and potentially choking off stronger investment spending.
–Finally, prolonged uncertainty about changes to policies could sabotage any attempt to implement a pro-growth agenda as businesses might hold off making any decisions until they have a clearer idea of government policies.
In short, this is an old expansion that still has the potential for stronger growth. However, it will need to be coaxed into better performance in a moderate and disciplined way. This discipline includes near-term clarity on a Washington agenda focused on policies that genuinely boost investment rather than restricting trade or legal immigration.
As of today, markets appear to be assuming that Washington will mostly make these choices, with the dollar and stock prices rising since Election Day. However, we will likely have to wait for at least a few weeks into the new Administration to see if this assumption was correct. In the meantime, long-term investors should note that the rest of the global economy also appears to be doing better right now, with international equity markets generally sporting more attractive valuations than the U.S. This being the case, despite enthusiasm about new policies from the U.S. government, global diversification seems more important than ever.
Chief Global Strategist