Friday, November 1, 2019

The weakest recovery and the longest expansion

If it weren't for Trump's trade wars and a dearth of business investment, the economy would be in excellent shape. As it is, growth continues along the moderate 2% path that it has followed for more than 10 years. It's been the weakest recovery ever, but also the longest business cycle expansion. And with no obvious excesses or systemic problems in view, it promises to continue. 

Chart #1

The Q3/19 GDP report—1.9% annualized growth—makes the current expansion the longest on record. Chart #1 shows the quarterly annualized growth rate of both nominal and real GDP. To be sure, 2% growth isn't a barn-burner, but it's impressive given the degree to which the manufacturing sector has been hit by Trump's tariff wars.

Chart #2

Since the recovery started just over 10 years ago, annualized GDP growth has been 2.3%; in the past year it was 2.0%, and in the most recent quarter 1.9%. As Chart #2 suggests, for most of this past year the market has been expecting growth to slow, and indeed it has. That is reflected in the more than 100 bps decline in the real yield on 5-yr TIPS since late last year. At today's real yield of a mere 0.05%, 5-yr TIPS appear to be priced to the expectation that real GDP growth will average about 2% per year going forward. Not surprisingly, Chairman Powell recently chimed in with a similar view, saying the FOMC expects moderate growth of about 2%.

Chart #3

Chart #3 compares real economic growth with private sector jobs growth. Not surprisingly, the two tend to move together: more jobs means more growth. The recent slowdown in GDP growth is reflected in a similar slowdown in jobs growth (the October jobs report was much better than expected, but it didn't do much to change the trend growth rate of jobs, which has been declining so far this year).

Both jobs and GDP have suffered from a lack of business investment, which likely has a lot to do with the uncertainties surrounding international trade. Private sector jobs currently are growing at pace of about 1.3% per year. If jobs grow at least 1% per year and productivity registers at least 1% per year (which it has in recent years), then 2% real economic growth is sustainable. (Jobs growth plus productivity growth is a decent first approximation for overall economic growth.) For growth to move higher, we would need to see a pickup in business investment, which not only creates jobs but improves the productivity of existing workers. A resolution to the tariff wars would undoubtedly prove a catalyst in that regard.

Chart #4


Demographic factors (more and more boomers are retiring) likely also play a part in this year's slowdown. Employers continue to complain that their biggest problem is finding qualified workers. Chart #4 shows that more small business owners than ever before report that "job openings are hard to fill."

Chart #5

But it's not like the economy is running out of available workers. As Chart #5 shows, the labor force participation rate (the percentage of the working age population who are either working or looking for work) looks to be increasing, albeit slowly. People who had been on the sidelines are being enticed to return, perhaps because they see better opportunities. Or in the case of not a few retired baby-boomers I know, they have decided that working is better than just sitting around watching TV. Regardless, there are still almost 6 million people out there who officially are looking for work, according to the BLS.

Chart #6

Chart #6 compares actual growth in real GDP to its long-term trend. (Note that this is plotted using a semi-log scale for the y-axis; a straight line on this chart thus corresponds to a constant rates of growth.) By only averaging 2.3% per year, the current recovery—the weakest in history—has resulted in a $3.4 trillion "shortfall" of growth relative to what might have been had the economy rebounded to its long-term trend as it did after every prior recession. Had this been a "normal" recovery, real median family income might have been almost 18% higher (~ $1000 per month) than it is today. 

Chart #7

Chart #8

Charts #7 and #8 show two measures of business investment. Both show that investment in the current business cycle has been weaker than in previous business cycles (especially in real terms, as Chart #7 highlights). Weak investment is likely major factor behind the economy's unimpressive 2% growth rate. Which is unusual, because corporate profits have been unusually strong in the past decade. 

Chart #9

What other factors might be restraining the economy's ability to grow? The size of government ought to top anyone's list. In the past 12 months, the federal government spent a staggering $4.5 trillion, almost 21% of GDP, and 8% more than the same measure a year ago. Even more staggering, though, is the composition of that spending: 72% of what the federal government "spent" in the past year ($3.2 trillion) was in the form of transfer payments (see Charts #9 and #10). That's money that is spent on things like healthcare, social security, income security, and interest payments on debt (as of last June the annual interest on federal debt outstanding was a little over $600 billion, or 13.3% of federal spending). Only 28% of federal spending was for goods and services (i.e., true purchases). Think of purchases as a proxy for what it costs to run the government, while transfers are basically entitlements—spending that is determined not by the budget process but rather by eligibility. 

Chart #10

Note how the growth in transfer payments has surged relative to the growth of purchases since the early 90s. As Chart #10 shows, since 1970 transfer payments have more than doubled relative to total spending. By far the biggest role of the federal government in today's economy is that of an income transfer agentNeedless to say, with $3.2 trillion per year (and growing) on autopilot, the potential for fraud and waste is ginormous. It's safe to say that the huge size of government transfer payments acts as a drag on overall economic growth and efficiency. And it's only going to get worse unless changes are made to entitlements eligibility (e.g., raising the social security retirement age and/or indexing social security payments to inflation rather than wage growth). 

These are problems that have been and are going to be with us for a long time. In the meantime, it's reassuring to note that financial market conditions look quite healthy:

Chart #11

The threat that an inverted yield posed to the economy (a threat I discounted long ago), has now disappeared. As Chart #11 shows, the Treasury yield curve is now positively-sloped (the 1-10 spread is about 20 bps today), and the real Federal funds rate is essentially zero. The Fed is not tight, and their recent decision to lower their target rate, while overdue, was welcome. The Fed has now caught up to the market and things are thus looking copacetic.

Chart #12


The real yield curve is actually a better thing to look at, and here too things look good. The blue line in chart #12 is a proxy for the overnight real rate, while the real yield on 5-yr TIPS is the market's estimate of what the overnight real rate will average over the next 5 years. Both are identical. By lagging the market's expectation of falling real rates for most of this year the Fed had been threatening with policy arguably "too tight." But now the Fed is neutral. A sign of relief.

Chart #13

Swap spreads (see Chart #13) are my favorite leading and coincident indicator of systemic risk, financial market liquidity, and fundamental economic health (the lower the better). Swap spreads are now low both here and in the Eurozone. Things could hardly be better.

Chart #14

Chart #14 shows Credit Default Swap spreads, a highly liquid and generic indicator of the market's confidence in the outlook for corporate profits. Spreads are quite low, which means the market is confident that the outlook for profits—and by extension the outlook for the economy—is healthy.


Thursday, October 31, 2019

Quick update on truck tonnage


Chart #1

Chart #1 is an updated version of what has become a perennial favorite chart, which shows that the growth of stuff carried by the nation's trucks is decently correlated with equity prices. Truck tonnage has been rising at a 3-4% annual rate for the past several years, and equity prices have been moving higher as well. This at the very least suggests that the damage from Trump's trade wars is still relatively minor, even though the manufacturing sector has taken a noticeable hit.

Chart #2






As I explained previously, the raw data for truck tonnage has been unusually volatile of late, so I've switched to a 3-mo. moving average, which appears to do a good job of filtering out seasonal adjustment defects. Chart #2 shows both the raw data (white) and the moving average (magenta). 


Monday, October 14, 2019

Net worth and risk aversion

Recent releases of estimates of households' balance sheet and financial burdens (as of June '19) reveal that net worth continues to rise at the same time that households' leverage continues to decline. This bears repeating: asset values are rising, but risk aversion remains strong, and that's quite healthy.

Chart #1

As Chart #1 shows, the net worth (total assets less total liabilities) of the US private sector (households plus non-profit organizations) in June 2019 reached the staggering sum of just over $113 trillion. That's almost double what it was at the depths of the 2008-9 Great Recession and almost 60% above what it was at its 2007 peak, according to the Federal Reserve. This was achieved as a result of strong gains in every category of assets: savings accounts, stock and bond holdings, real estate, and privately held businesses. What is perhaps most remarkable is that liabilities today have increased by only $1.5 trillion (10%) from their 2008 high.

Chart #2

As Chart #2 shows, for the past several years, the inflation-adjusted level of household net worth has increased by an amount that is very much in line with its historical trend: about 3.6% per year.

Chart #3

Chart #3 adjusts the data in Chart #2 for population growth. Here, too, we see that recent gains in real per capita net worth are very much in line with historical trends (about 2.4% per year). If there's anything unusual about this, it is that these gains have come despite the fact that the current business cycle expansion has been the weakest ever. Fortunately, it seems that unusually strong corporate profits have offset relatively weak growth, thanks largely to globalization, as I discussed here.

Chart #4

Chart #4 shows the ratio of recurring financial obligation payments to disposable income. Thanks to modest increases in liabilities and lower interest rates on debt, the true burden of household debt has declined significantly. Household financial burdens today are lower than at any time since the early 1980s.

Chart #5

As Chart #5 shows, household leverage (total liabilities as a % of total assets) has declined almost 35% since its high in early 2009, and has returned to levels not seen since the mid-1980s.

Chart #6


In my last post, I mentioned that recessions typically follow periods of excesses. The only "excess" that's obvious today is federal debt, which has risen to 78% of GDP, as shown in Chart #6.

But that's deceptive.

As an astute reader ("Cliff Claven") recently pointed out, the true burden of debt must take into account the amount of interest being paid on outstanding debt relative to GDP. Debt outstanding is quite high relative to GDP these days, but interest payments on that same debt are relatively low, thanks to historically low levels of interest rates. Federal debt interest payments this year will total about 2% of GDP, well below the all-time highs of 3% reached in 1991, according to the Office of Management and Budget (see Chart 4.05 on the aforementioned link). This may worsen, of course, if interest rates rise. But rising interest rates would probably be accompanied by faster growth and/or higher inflation, which in turn would increase nominal GDP, and that would mitigate the burden of rising interest rates. Moreover, faster nominal GDP growth would likely boost tax revenues.

In short, while federal debt looks bad on the surface, in reality we are far from facing a disastrous situation.