The Real Economy
I started writing about the economy, politics and financial markets after the Election of 2016, because I saw it coming. I am passionate about Economics, Politics and Investing, and with the Quarterly Update series, I hope to inform and help shape our conversation around what is really happening in America today. I believe in democratizing investment knowledge through the power of clean visualization and clear language, and the iterative improvement of both.
We lost hope during the worst of the Great Recession.
On October 10, 2010, lecturing in front of an esteemed audience at the International Monetary Fund, economist Mohamed El-Erian famously hypothesized that the United States and other developed countries entered a New Normal of lackluster economic growth. Mr. El-Erian thought the bursting of the Housing Bubble and resulting Financial Crisis created a systemic shock so great, that the United States and other developed economies were doomed to suffer lackluster economic growth for years to come.
The Great Recession ended in June 2009, but the economic recovery was stubbornly sluggish, as real growth averaged only 2.1% from 2010 to 2014.
By contrast, in the five years following the Recession of 1982, real economic growth averaged 4.9%.
The persistence of The New Normal befuddled economists, including those at the Federal Reserve. The Bernanke Fed mimicked Alan Greenspan's crisis countermeasures, extreme interest rate cutting. After the Internet Bubble burst, the Greenspan Fed cut Fed Funds to 1%, which created fertile ground for the Housing Bubble. After the Housing Bubble burst, the Bernanke Fed cut Fed Funds to 0%, and then held rates at zero for seven years. To add even more firepower, the Fed invented unconventional monetary policy. Whereas the Japanese and European central banks chose experimentation with negative interest rates, the Fed opted for an Unconventional approach, conducting large scale purchases of treasury and mortgage securities in a series of transactions designed to simulate the effects of negative rates. This unconventional monetary policy was called Quantitative Easing, ("QE") and from 2009 to 2014, the Fed executed the QE program three times in all, printing $3.5 trillion dollars in total.
The Fed repeatedly incorrectly hypothesized that asset price inflation would spur real economic growth
Jobs provide self-realization for some; but for most, having a job means a paycheck for the most basic needs: food, clothing, shelter and entertainment. If you don't have a job, you don't have the means to provide for yourself or your family. It does not take long for hopelessness to set in and kill confidence. After the Financial Crisis, the number of unemployed Americans more than doubled from 7.2 million to 15 million.
Americans qualifying for SNAP have household income levels at or below the federal poverty level guidelines. At the peak, 15% of our population, or 47 million Americans, relied on food stamps to help make ends meet. On average, the monthly benefit was $125 in 2017, which is just enough to buy a daily meal at McDonald's.
From 2006 to 2012, the number of Americans relying on food stamps surged by 80% from 26 million to 47 million. Put another way, the number of households requiring food assistance increased from one in twelve to one in six.
Election of 2016
Donald Trump became the 45th President of the United States by winning in "must-win" GOP states, such as Ohio and Indiana, and then flipping Michigan, Pennsylvania and Wisconsin in an unimaginable Rust Belt sweep of America's Heartland.
Since the Inauguration, Trump administration has embarked on Deregulation and Tax Reform policies which have increased business confidence and the optimism of CEOs. As companies increase their capital investments, more people have returned to work, which has created a positive feedback loop in our service economy. U.S. Real GDP growth is accelerating, and most recently achieved +2.8% growth vs. last year. On a seasonally adjusted basis, real GDP growth achieved the elusive 4% level.
During the Great Recession, we lost 8 million jobs in 1.5 years. It then took 5.5 years to get those jobs back during the New Normal.
The strengthening economy has positively jolted the job market into record territory. As of August 2018, there are 149 million employed Americans, representing an increase of 19 million jobs since the Great Recession, and 11 million above the previous high of 2007.
Started by the Department of Labor in December 2000, the Job Opening and Labor Turnover Survey, monikered "JOLT", is a monthly survey of specific job openings and vacancies conducted by The Bureau of Labor Statistics.
Statistically speaking, there has never been a better time to find a job. According to the latest JOLT report, there are 6.9 million jobs available, which is more than the 6.2 million unemployed Americans. Jobs are now searching for people! What a difference in a decade. Compared to 2009, there were 15 million unemployed Americans and only 2.2 million job openings, a deficit of 12.8 million.
Rosie is my symbol for the America's working class. It's been a tough 25 years, with two wars, two bubbles, two crises and two recessions, but this moment for American labor is the best since China joined the WTO in 2001. Bountiful job openings have presented Rosie with incremental hours to fill a 40-hour week and the extra income is helping to make ends meet:
"She has a little bit more money because she is working more hours or a second job."
-- Todd Vasos, CEO of Dollar General, at Goldman Sachs 25th Annual Global Retailing Conference
Jobs Provide Income but Confidence and Sentiment Drive Spending
Since 1967, the Conference Board has been conducting a monthly survey of 3,000 households measuring their feelings about current business conditions and their own job prospects. The Consumer Confidence Index is an important economic indicator because the U.S. consumer drives two-thirds of the U.S economy through the consumption of goods and services. (The delivery of consumer goods and services creates jobs). The survey asks respondents to gauge their Present Situation as well as their Future Expectations.
Consumer Confidence peaked at 143 during the Internet Bubble. Interestingly, confidence made only a modest Housing Bubble high at 110 before the bottom fell out. The Financial Crisis destroyed jobs, and confidence cratered to 27, as the severity of the Great Recession, for a moment, also destroyed hope, the collective assessment of future expectations.
Since 1952, the University of Michigan has been conducting its Consumer Sentiment survey. Each month, at least 500 households are asked 50 standard questions regarding their current situation and their assessment of the short term and long term economy. The Consumer Sentiment Index increased after the Election of 2016, but now looks wobbly.
Consumer Confidence and Consumer Sentiment would be stronger with more money in Rosie's pocket. However, since the Great Recession, both the Average Hourly Earnings and Wage Growth Tracker indicators have been muted, only recently piercing 3% growth.
Average Hourly Earnings is calculated by the Bureau of Labor Statistics. Prior to the Great Recession, average hourly earnings routinely grew by over 3 or 4. After the Great Recession, Average Hourly Earnings grew by only 2%.
The Atlanta Fed's monthly Wage Growth Tracker shows similar sluggishness. From the inception of this indicator in March 1997 until 2008, wage growth averaged 4.3% per year. However, from 2009-2018, wage growth slowed by 1/3, growing only 2.5% per year for the past decade. There are real limits to working more to earn more, as the average hourly work week of 34.5 hours is back at historical high levels. Rosie may be able to make ends meet by working extra hours, but she is not seeing the wage gains to help push her ahead. This is restraining consumer confidence.
Real wages in America have been stagnant for years. Since 2010, despite the massive liquidity injection of Quantitative Easing and ensuing asset bubbles, the Consumer Price Index has not lifted off. Otherwise tame at only 2% inflation, this rate of inflation is still enough to neutralize nominal wage increases of 2.5% to 3%. Real wages in America have been stagnant for years.
From Pax Americana Globalism to Economic Nationalism and The Trade War: Why and Why Now?
World War I and World War II forced a rather isolationist, and militarily unprepared, United States to mobilize its civilian population into a wartime economy in two "total wars" which wreaked global death and devastation at unprecedented scale. In World War I, America mobilized 4 million soldiers, of which 116,516 were killed and 320,000 wounded. A generation later, World War II, killed 407,316 Americans and wounded 671,278, over one million casualties in all. At the peak of American entanglement, 12.2 million Americans wore military uniform in 1945, comprising 8.7% (or 1 in 11) of the population of 140 million.
After WWII, the United States emerged as a global superpower whose mission was to contain the spread of Communism around the world. America proved willing to commit troops in wars in Korea, Vietnam, and the Middle East. Observing that democracies do not go to war against each other, America made significant investment in creating global institutions to exercise soft power through the influence of diplomacy and economic trade.
Fast forwarding this entire article by twenty years. Ross Perot was right!
I was in tenth grade when I learned about Ross Perot. In his 1992 Presidential bid, the third party candidate Ross Perot warned Americans that a North American Free Trade Agreement would result in a "giant sucking sound" of millions of American jobs moving into Mexico.
Bill Clinton won the 1992 Presidential election, and when he took office, there were 17.1 million manufacturing jobs in the United States. I was a senior in high school when NAFTA was created in 1994. Eighteen years later, in March 2010, the number of manufacturing jobs in America had fallen by nearly 33% to 11.5 million.
Millions of Americans lost good manufacturing jobs after NAFTA. From 1992 to 2016, three different administrations, Bill Clinton, George W. Bush and Barack Obama, continued the economic and trade policies which came at the expense of the Heartland. Either, the experts were wrong, or they deliberately sacrificed the American Middle Class in the name of globalization.
Election of 2016
In my opinion, Trump won the Election of 2016 because he articulated a message of hope to America's beaten down and forgotten working class. For America's 600,000 steelworkers, the steel tariffs constitute a lifeline. The path to reelection will also run through the Midwest. While economists may deplore the bluntness of protective tariffs, the Trade War is a highly precise political message to the President's base.
Part 1. What America Wants Longer term, America wants to maintain her historical greatness as the world's sole superpower. To achieve this, America is renegotiating trade agreements to protect American jobs at home while also promoting access to markets aboard. Regarding China, the U.S. is taking a hard line against Chinese practices around intellectual property and technology.
Part 2. What China Wants Restoration of historical greatness as a super power of equal stature to the United States. In the short term, China needs to maintain steady economic growth and create millions of jobs within its own Heartland. Since its entry into the WTO in 2001, China has been a tremendous economic success. In hard terms, $4 trillion dollars of success in just a decade. Not bad for ten years of work!
Those foreign exchange dollars earned by China mirror the rise in unemployment and hopelessness in the United States, the other side of China's export led growth model.
America's populist backlash in 2016 is reaction from the Heartland that I think China can understand, with empathy. I think China is willing to make a deal, but they need assurance that the United States will respect and honor the outcome of this (final) trade negotiation. For the Chinese, a quick resolution would be nice, but if the President wants to savor the victory of a brutal Rock 'em Sock 'Em style fight, they may be forced to go toe-to-toe for a few rounds to earn respect. Please pull your punches.
The Art of The Deal
The U.S. economy is the strongest it has been in over a decade. And American workers are in the best job market on record. President Trump campaigned on an American First strategy, and in this moment of strength, the Administration is demonstrating to its political base, in full theatrics, the resolve to fight to Make America Great Again, and neither friend nor foe be spared. The American trade strategy is to divide and conquer by continent. First, NAFTA, then sweetheart deals for the United Kingdom and Australia, which will provide outposts into Europe and Asia, as well as the strategic encirclement of China. It's a gamble. But if the U.S. wins concessions, and the outcome is sustained improvement in the American economy, then it's four more years.
Consumer Spending Drives Two-Thirds of the U.S. Economy
Savings as the most important Financial Rorschach
Income is either spent for consumption now, or income is saved for consumption tomorrow. The Productivity Boom of the 1990s created strong income growth throughout the Clinton presidency. During this period of prosperity, the United States pushed global trade liberalization. The United States entered into NAFTA in 1994 and also encouraged China's entry into the World Trade Organization 2001.
Personal Savings. In my opinion, Economic analysis should start with an understanding of what motivates Americans to save. Savings creates capital, but it is spending that drives the economy. From 1998 to 2008, Americans cut their savings in half for a decade, enjoying the asset price inflation of the Internet Bubble and the Housing Bubble. However, since the Great Recession, Americans have boosted savings back to 6% of disposable income. Conspicuous consumption may have been cool then, but you need a good credit score to get a date tonight.
Retail Sales. The U.S. Census Bureau, within the Department of Commerce, is responsible for collecting and analyzing retail sales data. Retail sales plunged during the Great Recession, down 10% at its worst level, and failed to climb out of the hole. In 2011, Retail Sales rebounded +8.7% but during The New Normal, retail sales growth tapered to zero growth by 2016.
The Business Cycle is the way in which our economy expands and contracts over time. When a consumer makes a purchase today, the sale at the Cash Register triggers replenishment orders at the factory. In June 2018, the U.S. government reported continued strength in the economy, with real GDP increasing +2.8% vs. the prior year and +4% on a seasonally adjusted basis. In my model, sales drive economic growth, with a six month lag, so Q2 GDP was led by +6.3% retail sales growth in December 2017.
Retail sales excluding food and autos, most recently registered +7.2% growth in July 2018 and +6.8% in August 2018. Based on this strength, I forecast Real GDP to sustain 4% growth through 2019. My current economic forecast is sunny with cloud cover from the Trade War.
Forecast: If the United States is successful in winning trade concessions, it's all sunshine.
However, there are two critical risks:
Labor Shortage and Possible Wage Inflation. By late 2019 and 2020, our growth outlook may be downgraded because the economy will have exhausted its supply of hourly labor. While some businesses may choose to defer growth plans due to the lack of labor, other companies may choose to use high pay increases to boost their work force. Real wage inflation would be a boon for hourly workers on Main Street, but scrutinized by Wall Street as inflationary fears would bust asset prices.
Fragile Consumer Confidence. It's late in this economic expansion, but even after saving 6% of their paychecks, American consumers are spending more money, with increasing acceleration. Last reading, U.S. Retail Sales were up +6.8% which forebodes continued economic growth in the quarters ahead.
Minyoung Sohn, CFA. Portfolio Manager, (MEIFX) Meridian Equity Income Fund
updated: September 20, 2018
I love this iconic illustration. Rosie the Riveter was created by J. Howard Miller in 1943 for the patriotic motivation of the employees of Westinghouse Company during the wartime effort. Rosie is my symbol for the American middle class, which has experienced two crises and two recessions since 2000.