posted on 05 March 2016
by Gene D. Balas
Forecasts for modest economic growth in the U.S. (and the rest of the developed world) are hard to avoid these days. Some investors may worry that this will translate into restrained profit growth in U.S. stocks, which may keep some asset returns muted. If these forecasts are correct, how might investors respond?
Two possible approaches might be to either modify one's expectations or change one's opportunity set. To understand these options better, let's get a deeper understanding of economic growth, which can be measured by gross domestic product, or GDP. The long term potential rate of growth for the economy is basically the growth of the labor force plus changes in how much per hour each person produces, better known as productivity gains. If the economy grows faster than this long term potential, unemployment tends to go down and inflation might go up, though there are no certainties in this relationship. (The reverse is true as well.)
Lower Estimates for the Potential Rate of Economic Growth
Right now, the long term potential net of inflation growth rate of the U.S. economy that the Federal Reserve uses in its deliberations is a range of 1.8% to 2.3%, as contained in the Summary of Economic Projections published following the Fed's December meeting. That may seem rather low, in a world where many recall years when GDP grew over 3% or even more. But there are reasons why slow growth is what we can expect - and these reasons are not necessarily due to complicated factors conspiring to drag the economy down. Instead, they are fairly basic, and relate mainly to the aging of the population and slow development of new technologies that make workers more efficient (that is, instead of replacing them altogether).
First, consider the basic estimate of long term potential GDP in the nearby graph. Note that this is not actual, realized growth; rather, this is what we can expect from the economy over the long term, absent any shocks to the upside or downside. You'll see that the long term potential growth rate of the economy, as published by the U.S. Congressional Budget Office, is right within the range of the Fed's forecasts of roughly 2% or so.
Growth of the Labor Force Is Expected to Slow
Now, let's deconstruct that into the components of potential GDP growth. First is growth of the labor force. We'll start with how the growth rate of the working age population in the U.S. has decelerated in recent years - not surprising as Baby Boomers have been retiring. This trend is expected to continue into the future, not just due to retiring workers, but also to low fertility rates in recent decades.
Productivity Gains Have Decelerated
Next, consider the effects of productivity, which we would add to growth of the labor force to determine long run economic growth potential. Here, we see productivity has been on a downtrend in recent years, vexing policymakers and stymying efforts to goose output.
Now we get to the crux of the issue. Productivity gains are essential for improving our standard of living. They also bolster corporate profits - a driving force behind stock market gains. In the nearby graph, consider how correlated productivity gains have been to wages.
Amplifying productivity gains is the subject of huge debate, not just as to the cause, but as to how to increase it. Factors considered are the education and skills of the workforce, the slow adoption of new technologies - or even whether new technologies even have a tangible benefit in the workplace. A smartphone may not actually add much in the way of GDP growth the way that the telephone once did. This discussion, however, is far from resolved and is beyond the scope of this article.
What This Means for You
What does this mean for you? First, consider FinLife® guidance, a service that United Capital offers to help keep your portfolio on path to attempt to achieve your objectives, as we discussed recently in a previous blog post. Next, if growth in the U.S. might be expected to be slow, one idea might also be to consider investing overseas. Emerging markets are volatile, so they're not always appropriate for every investor or in every time period. But some emerging markets do have stronger rates of labor force growth rates and, more importantly, are still benefiting from the adoption of new technologies (or even more basic ones, such as transportation systems). Thus, they may offer a higher rate of economic growth. That may augment profits of companies doing business there. These types of investments are for the long term, and one must look past short term volatility.
Your United Capital financial adviser is the best place to start with a discussion whether, at some point, you might consider modifying your investment strategy, or whether it is your expectations that must be reevaluated. Either way, your United Capital adviser is well suited to helping you navigate your investment journey.
Investing involves risk, including possible loss of principal, and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. The information contained in this piece is intended for information only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. Please contact your financial adviser with questions about your specific needs and circumstances.
The information and opinions expressed herein are obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital. Opinions expressed are current as of the date of this publication and are subject to change. Certain statements contained within are forward-looking statements including, but not limited to, predictions or indications of future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties. Indices are unmanaged, do not consider the effect of transaction costs or fees, do not represent an actual account and cannot be invested to directly. International investing entails special risk considerations, including currency fluctuations, lower liquidity, economic and political risks, and different accounting methodologies.
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