It Might Be Common Cents – You Decide On July 27, 2018

July 27, 2018, by John Norris

Something kind strange happened this morning. After 8.5 years of economic expansion and almost 3 years into a Fed tightening cycle, the Bureau of Economic Analysis (BEA) released the best quarterly GDP (Gross Domestic Product for those keeping score at home) report in recent memory. To be sure, ‘you’ have to go back to 2Q and 3Q 2014 to find comparable quarterly results, and I might still argue this was a better report.

The only downside, if you want to call it that, was a pretty sharp decrease in private inventories, which shrank by an annual average of $27.9 billion. However, is that really bad news? After all, a change in inventories can sometimes be a by-product of a higher than expected increase in consumer expenditures. Simply put, companies just weren’t planning on the demand, and their proverbial shelves emptied a bit. Intuitively, they will place orders over the coming months to increase their stock.

But is $27.9 billion really that big of a deal in a $19 trillion economy? Not really, but the accounting of it can be. You see, inventories grew at a $30.3 billion clip in 1Q. As such, that is a $68.2 billion swing over 3 months, which is a different story. By the time the BEA got finished with its calculations, this negative swing in inventories took a whopping 1.00% off of economic growth during the quarter.

The rest of the economy? Brother, there isn’t much in the data for the bears. In fact, those that can find a dark cloud in this silver lining probably don’t like balloons and ice cream either. They are mean to animals and small children, and got coal in their stocking from Santa Claus. That sort of thing.

Still, there will be those who will point out the price index in the report was the highest in long, long time. I am here to tell you: the BEA reported a 3.0% inflation figure, which is rarified air, or has been over the last decade. Surely, the much awaited spike in prices is just around the bend!

Tighten your belts folks; it is going to be a helluva ride!

Maybe, but it seems a good chunk of our inflation was contained to residential and structural investment, and exports. Personal consumption expenditures? Up 1.8%. Imports? Strangely enough with all the tariff talk, they rose 0.1%. By the time you factor some of this out, prices for ‘final sales to private domestic purchasers’ rose an annualized 2.3% during 2Q, which was lower than the last 2 quarters. Besides, and be honest, who here is really losing sleep over the potential for 3.0% inflation? Other than those folks who bet against it with some kind derivative strategy or interest rate swap?

I just finished lunch with an old friend of mine who is in the industry, but at a different firm. We talked about the economy and the markets, and he is much more bullish than I am on both. Don’t get me wrong, I am not necessarily bearish, but my buddy was talking about the economic equivalent of unicorns passing out free beer.

His reasoning is ‘we’ have entered a lower tax and regulatory environment, just like we did in the early 1980’s…and look what happened over the next two decades in the markets and all of that! To be sure, there is some measure of truth to his contention (a lot actually), but I just can’t get to his overall level of enthusiasm. The reasons are twofold and pretty simple.

First, interest rates were significantly higher then than they are now, significantly. This means we have mostly been in a falling rate environment for the last 3 plus decades. Since there is usually an inverse relationship between interest rates and asset prices, it makes perfect sense the markets would have behaved extremely well during the 1980s and 1990s. It is just math, for the most part.

Second, the US economy had a huge demographic tailwind back in those halcyon days. The Baby Boomer generation, the biggest one in our nation’s history in absolute size, was coming of age during those years WITH a higher percent of females joining the official workforce. As a result, the labor force participation rate and employment to population ratio shot up. Not surprisingly, with more Americans looking for work and working, median household income, read household purchasing power, went up at an increasingly faster rate.

Further, I would argue the 1990s were the high point of that two decade period for one primary reason: the Baby Boomers were hitting their earnings stride at the same time the Silent Generation, significantly smaller, was hitting retirement. In short, more people were paying into ‘the system’ than taking out of it.

When you couple those things WITH a lower tax and regulatory environment, brother, it will/would/would have been/be almost impossible to not have good results.

Conversely, today, we have an already low interest rate environment in a heavily indebted world. As such, the prospect for lower interest rates to help fuel a rally in paper asset prices is, well, remote. Simply put, again, it is just math. At the end of 1981, the yield to maturity on the 30-Year Treasury Bond was in excess of 13%. Today, it is closer to 3.1%. If interest rates fall much further from THIS, it is a VERY real probability the economy has collapsed, and stocks generally don’t go UP in that scenario. Essentially, we are at or near a point where a decline in interest rates will NOT help fuel a multi-decade economic expansion.

Also, the generational shift has been, is, and will continue to be the opposite of the 1980s and 1990s when the Boomers replaced the Silent Generation. To that end, there were 3,965,000 live births in the United States in 1953. People born in this year will turn 65, the traditional retirement age, at some point in 2018. By comparison, there were 3,333,279 live births in the US in 1978, and these people will hit 40 this year. That is a difference of (631,721).

While there have been deaths and changes in immigration patterns over the years, the numbers flat out suggest more Americans will be hitting retirement age than their peak earnings years (arguably) this year. This has been the case each year since 2012 AND will continue (by this measure – live births per calendar year) until 2030. However, the discrepancy in 2029 is particularly meaningless.

Obviously, you can take exception with my use of 40 and 65 as important ages, but the rest of the birth data pretty much says the same thing: our workforce has been aging and it will continue to age for about another decade. At this point (2028-2030), it will start getting younger, as the Millennials hit their stride and the Boomers, well, start hitting their, shall we say, actuarial limit…..with increasing frequency for the next decade.

Will the 2030s be a repeat of the 1980s and 1990s? That is almost impossible to predict, but the demographics will be a positive for economic activity for the first time in literally decades. Interest rates? Probably not the same amount of fuel as the early years of the Reagan Administration. Tax and regulatory environment? Who knows, but, at this time, I am not sure American society is AS business friendly as it was 35 years ago or so.

Thanks to the missteps corporate America has made over the years, the end of the Cold War, and the growing inequality of wealth in the country, it would certainly be politically understandable if the average American isn’t as, shall we say, capitalistic as it was back in the day. How will this change as the Millennials get older and more ensconced in the economy is anyone’s best guess at this time….but this generation is widely considered to be the least capitalistic generation in US history, at least outwardly. With that said, I don’t know too many people, regardless of political persuasion, who really enjoy turning over their OWN paycheck to the government. It is ALWAYS easier to turn over someone else’s paycheck, particularly if they make more than you do (or you think they do)! Seriously.

So, will the Millennials be more business friendly in 10-12 years than we presume them to be today? I haven’t the foggiest, but I would imagine by some small measure…but probably not by the same measure we were in the early 1980s.

In the end, and it is getting late here today, the economy grew at a robust rate in 2Q 2018. It was a really good GDP report, and I mean really good. While I will stop short of saying it was ‘historic’ as the President did, it was certainly welcome and a little unusual this late in both the economic and monetary policy cycles. Hey, it is a gift horse and I ain’t looking it in the mouth.

Still, as good as this morning’s number was, we will need more of them AND economic friendly policies to carry us through to 2030….good old Mother Nature and Father Time can shoulder some of the burden then.