Reasons for Optimism About the U.S. Economy
- Labor shortages, new technology and rising inequality are three factors sustaining U.S. economic growth despite recession fears.
- Central banks may overestimate their abilities to direct the global economy, particularly in the U.S. where current homeowners are largely shielded from interest rate hikes.
- Despite a low consumer sentiment, J.P. Morgan strategist David Kelly says the U.S. is on track for continued economic growth. As inflation decreases, investors can expect bonds to normalize as a long-term portfolio diversifier.
It’s the great economic mystery of 2023 — where’s the recession? While many forecasters thought the high inflation and repeated rate hikes following the COVID-19 pandemic were harbingers of a financial downturn, the American economy has proved surprisingly resilient.
Either that, or the Fed’s contractionary monetary policy simply isn’t working. Perhaps inflation slowed in due course after a period of stimulus-driven, heightened consumer spending, and America’s continued economic growth is largely sheltered from central bank rate increases. In this view, the standard 60/40 portfolio allocation should expect a normalized return rate in the coming years as the COVID-era abnormalities fade out from the global economy.
David Kelly, Chief Global Strategist and Director of the Global Market Insights Strategy Team at J.P. Morgan, is optimistic about the U.S. economic outlook in large part because of the job market. Unemployment has remained below 4%, and, as of October, the Bureau of Labor Statistics reported 8.7 million job openings in the U.S. economy.
“It’s hard to say you’re in a recession if you’re creating hundreds of thousands of jobs,” David says. On top of that, David explains that there’s been no “boom” in a cyclical sector of the U.S. economy that would usually indicate a coming recession, as was the case when the boom-and-bust housing market led to the financial crisis of 2008.
This upbeat economic outlook is hard to find among U.S. consumers, a point David shares with Alan Dunne on an Allocator Series episode of Top Traders Unplugged. Despite all the metrics indicating economic growth, consumer sentiment remains overwhelmingly negative. In what feels like an era of great economic uncertainty, David argues why investors should feel confident in a standard allocation strategy.
The labor shortage impact
With approximately 1.3 job openings per unemployed person, the U.S. economy is at full employment — nearly anyone who wants a job can find one. Indeed, many industries are experiencing an acute labor shortage, with education, healthcare, food service and hospitality among the most desperate for workers.
Yet the downside of a full employment scenario is that it slows economic growth. When companies struggle to recruit skilled employees, they’re forced to sweeten the pot with higher salaries and expansive benefits packages. While it’s great for individuals, these sudden wage increases raise the cost of doing business, ultimately contributing to higher inflation and a slowdown in economic development.
“It’s like you’re riding a bike uphill slowly,” David explains. “If you’re riding fast, you’re pretty stable, but if you’re riding slowly, it doesn’t take much to knock you over.”
Falling down, to stick with the metaphor, sounds like a recession, and David admits there’s a good chance of some economic contraction in the next two years. But he remains bullish on his overall outlook in part because of how quickly technology is reshaping the labor market.
In a labor shortage, companies are motivated — if not forced — to invest in efficiency. From artificial intelligence to process automation, organizations in every industry are finding new ways to increase productivity. If there is a sudden recession, productivity gains could quickly help pull companies out of the dip.
As for workers who may lose their jobs to automation, David is confident new opportunities will pop up. “The economy has always created jobs,” he says. “Humans have an almost unlimited demand for stuff and services … the stuff that we want is going to evolve over time.” The cycle of efficiency, new industries and rehiring could keep unemployment low and support long-term economic growth.
The homeowner’s protection from rate hikes
In addition to the relative job security of low unemployment, many Americans are sheltered from the tight squeeze of the Fed’s rate hikes. The overwhelming majority of American household debt is held in mortgages and HELOCs. U.S. mortgages are typically held on fixed-rate terms, and many homeowners either bought or refinanced during the low-rate period of the pandemic.
For first-time homebuyers, higher borrowing costs are a different story. It’s more expensive to take out a new mortgage, and the sustained low inventory drives prices even higher. The National Association of Realtors recently estimated the sale of existing homes to be at its lowest rate in more than 13 years, and new construction can’t keep up with demand.
While it might seem like a pricing bubble, experts agree that the housing marketing is nowhere near crashing. Debt service as a ratio to disposable income is comparable to pre-pandemic levels and far below the Global Financial Crisis (GFC). Existing homeowners are largely sitting on piles of equity, and new homeowners — once their patience pays off and they can close on a house — are similarly positioned to stay afloat in their loans. Banks have more regulations in place now than they did prior to the GFC, and the mortgage system as a whole is safer than it was fifteen years ago, making a sudden crash more unlikely.
Beyond home ownership, U.S. consumer behavior generally spends more on services — think tourism, entertainment, health expenses or even software subscriptions — than on purchasing manufactured goods. David says, “The economy is much more about services and much less about investment spending [on capital goods] today. Therefore, it’s much less sensitive to interest rates.” A new car loan is subject to high interest rates, but a dream vacation isn’t, unless the whole thing goes on a credit card.
To that point, many Americans have savings in cash accounts. “When interest rates go up, they’re gonna all get a pay increase,” David says. The combination of growing home equity on fixed mortgage, high-yield savings accounts and the booming service economy means American consumers as a whole are relatively shielded from interest rate hikes.
A new global economy
But Alan points out these arguments are perhaps uniquely applied to the U.S. What about deglobalization, the rise of industrial policy and investments in sustainability that may impact inflation worldwide? “There’s a whole raft of structural factors that may elevate inflation over time,” Alan says. In response, David looks at the structures moving against inflationary pressure.
As for international trade, a true reversal of decades of globalization is unlikely. No country will achieve economic independence, but politics may have a bigger impact on trading agreements. “I think you could end up with a new equilibrium where you’ve got the trading bloc of the autocrats and the trading bloc of the democracies. A lot of people talk not about outsourcing or resourcing, but friend-sourcing.”
If manufacturers step back from cheap labor in China, maybe they look instead to Malaysia, Vietnam or Mexico. If Europe stops importing natural gas from Russia, they’ll look instead to North Africa, the Middle East and the U.S. More trading partners means more competition, which moves prices down.
The modern world defaults to low inflation
“When I look at inflation in the 1970s and then I look at inflation in the early 2020s,” David says, “what strikes me is the period between when inflation basically went sideways or down for 40 years.” Perhaps those decades-long checks to inflation will resume once the dust settles on the post-pandemic economic disruptions. David names three factors that keep inflation in check.
Lack of unions
This feels counterintuitive considering the past year’s media coverage of teachers, automakers and Hollywood screenwriters on strike. But David points out that while in the 1970s approximately 25% of the private sector was unionized, today it’s only about 6%.
“Workers don’t have bargaining power, and that stops a wage-price spiral,” David says, referring to the price increases on consumer goods that normally follow more disposable income from higher wages. Even in Europe, where union participation is higher across the board than in America, union membership is falling in most countries. When workers can’t demand higher wages, there tends to be a deflationary effect.
While artificial intelligence and other advancements may make our lives easier, they also drag down inflation. “Information technology tends to help buyers more than sellers,” David explains. Consider: New tech makes companies more efficient and productive, which means they’re more likely to invest in revenue growth and profitability than contribute to a rising cost of labor. In addition, if humans’ jobs can be replaced by machines, companies will employ fewer humans.
Technology can also make markets more competitive by putting newer, smaller companies on a level playing field with established enterprises. Competitive market forces tend to drive prices down on both goods and services as consumers have more choices and will gravitate toward the best deal.
Another maxim of our times — the 1% keep getting richer. It’s no secret that wealth inequality is on the rise in recent decades, touching every continent. Even as globalization has done some work to reduce inequalities between countries, wealth gaps within countries have continued to widen. When it comes to economic behavior, the wealthiest people handle money differently than the majority of the population.
“Half of the income in America is received by the top 10% of households,” David explains. “The biggest difference between the top 10% of households and everybody else is that the top 10% save about 37% of their income. Everybody else doesn’t save anything at all.” This creates a sort of leakage in the national cash flow. If, for every $100 a wealthy person receives, they put $37 into savings and investments, that takes a significant portion of money out of the consumer economy, ultimately driving prices down.
An investor’s response
So if companies are positioned to benefit from new technology and capital investments, that puts a positive outlook on equities. As for Treasury bonds, the U.S. continues to run a massive deficit. This could incentivize higher yields in order for the global capital market to fund the U.S. government, making bonds an attractive long-term diversifier and source of income.
In periods of high inflation and rapid rate hikes — like we’ve just lived through — bonds and stocks end up moving in the same direction. But in periods of slower, sustained economic growth, bonds regain their portfolio-diversifying impact. “A year in which bonds are not doing their job in a healthy diversified portfolio, they’re not zigging when stocks zag, is actually very rare,” David says.
Looking ahead, David forecasts a 7% return on the 60/40 portfolio. He notes that investors will need to be more active in their asset allocation rather than just following an index fund, as some of the top high-growth stocks may be overweight following the better-than-expected economic data this year, but that a balanced portfolio should win out. “The top seven or top ten stocks may get lower returns going forward, but the other stocks in the S&P 500 should do better [than 7%].”
Seven percent may seem modest considering historical market returns and the rapid gains in the volatile post-COVID bull market, but David advises realistic expectations as the safest approach. He asks, “If [7%] is not enough, then how are you spending money? How are you earning? You’ve got to make those two things work in a way that allows markets to help you out. Don't expect markets to do what they can’t do for you.”
This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.
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