Global Trend

Even as businesses struggle to meet resurgent demand, the U.S. economy is returning to its long-term growth path.  What trajectory will this recovery and subsequent expansion follow? What happens after the current effects of government spending, pentup demand and loose money begin to wear off? And what are the implications for investors, workers, and consumers? We’ll show you.

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As the Trends editors forecasted as far back as March 2020, COVID-19 has transformed how we live and work in ways that will impact our businesses and lifestyles even after memories of the pandemic itself have faded. Companies moved rapidly to deploy digital technologies, dramatically accelerating trends that were already unfolding (at a much slower pace) before the crisis. Work went remote.  Shopping, entertainment, and even medicine went online. And businesses everywhere scrambled to deploy digital systems to accommodate the shifts.

Many of the resulting changes in consumer behavior and business models will persist, although perhaps not with the same intensity as during the crisis. These promise big benefits in terms of higher productivity, resilience, and innovation. And, unless business leaders and policymakers take action to mitigate some of the unwanted effects, this could also lead to what the McKinsey Global Institute calls “an uneven economic recovery,” with 

- rising inequality among workers

- differing outcomes for consumers depending on their age and income levels, and 

- a growing gulf between outperforming companies and the rest. 

Now, as America emerges from the pandemic and harnesses the Mother OF All Recoveries (or MOFAR), it’s time to consider how this massive shock and our response to it may reshape the future of work, productivity, consumer behavior, and growth in the United States and other advanced economies. 

Let’s start with an overview of where the economy currently stands and where it’s headed. 

To put things succinctly: the U.S. economy has emerged in amazingly good shape! In fact, the private sector is wealthier and more prosperous than ever before although the benefits have been distributed unequally and often rather crudely. The public sector, on the other hand, has rung up a tab that will take generations to fully absorb. Lurking in the background of this surprisingly good news, the specter of inflation is creating widespread anxiety.

The Federal Reserve recently released its estimates of household balance sheets, which are summarized in an image in the printable issue labeled Chart #1. Thanks to strong financial markets, lots of saving, real estate appreciation, and only a modest accumulation of debt, household wealth has reached un-precedented heights despite the pandemic.

Chart #2 converts the net worth numbers in Chart#1 to real (inflation-adjusted) figures and plots the data using a y-axis that is logarithmic; that means steady growth rates appear as straight lines.  This chart clearly shows that the real net worth of the US private sector has grown slightly more than 3.6% a year over the past 70 years!

To fully appreciate this as a manager and investor, it's worthwhile comparing Chart #2 to Chart #2A, which shows the S&P 500 growing at an average annualized rate of 7% over the past 70 years. Both charts paint a similar picture: net worth and equity prices have appreciated on average at a fairly steady rate over the long haul, and the trend lines which money manager Scott Grannis added to each chart do a good job of highlighting above trend and below-trend-years. Both suggest that valuations and net worth today are somewhat above the long-term trends, but nothing approaching the egregious levels of the 1990s. In short, the current period does not stand out in any extraordinary way from America’s long-term experience.

Chart #3 uses the data from Chart #2 and divides it by the population of the US to get real per capita net worth. Here, we see a fairly steady 2.8% rate of growth over the past 70 years; but in this case, the past year is a bit more "above trend" largely due to wealth shifting from government to the private sector. Looked at this way, the average American's share of total wealth is currently about $410,000.

 

Chart #4 in the printable issue, shows the ratio of total household debt to total household assets, which can be likened to the average degree of leverage employed by the private sector.

Here we see a rather dramatic and ongoing decline in financial leverage that began back in 2008, in the depths of the Great Recession. That recession, as you might recall, owed quite a bit to the private sector's use of excessive leverage to buy homes in previous years. Fortunately, we've now rolled back the clock on leverage to levels last seen in the early 1970s.

In Chart #5, we see that the gains in equity prices in the past year have been accompanied by a decline in the VIX "fear" index. Today, the VIX is still a bit above the levels that have prevailed in so-called "normal" times, and this implies there is still room for further stock market gains, provided we avoid unpleasant surprises. In fact, the Trends editors are quite optimistic about stocks in the coming decade.

Chart #6 tracks the rolling 12-month total of federal spending and tax revenues. As discussed in prior issues, Covid-19 provided the rationale for the most dramatic increase in Federal spending since WW II. But thanks to the avalanche of tax receipts in May 2021 things are now beginning to return to normal. This will soon be accompanied by a lessening in the pace of growth of spending as the Biden administration fails to pass additional spending programs.

 

Beyond that, government spending must be reined in even further in order to avoid a serious crisis down the road. As we’ve explained in prior issues, the problem is not so much the amount of debt, but rather the fact that such levels of spending are inevitably wasteful and create fertile terrain for graft and corruption. Stimulus checks and PPP loans were government-created solutions to government-created problems. The fact that we are not in ruins today is testimony to the hard work and prudence of our private sector. Since the government can never spend taxpayers' money as prudently, wisely, and efficiently as taxpayers can, we need to cut spending so that taxes can remain low and the government is forced to make the most of the funds it’s given.

As we alluded to earlier, the recent surge in government revenues highlighted in Chart #7 owes a lot to a surge in individual income tax receipts, which in turn have been boosted by capital gains revenues thanks to the strong stock market. Corporate income taxes have also increased thanks to strong earnings growth in the latter half of the year. The Laffer Curve assumptions behind the 2017 tax cuts seem validated.

One thing that makes the current mountain of Federal debt manageable is the relatively low cost of interest on that debt relative to GDP. As hard as it may be for many people to believe, total interest payments on the federal debt as a percent of GDP, are currently about as low as they have ever been, even though total debt as a percent of GDP is higher than at any time except for the WW II years. Unfortunately, the blue line on Chart #8 is virtually certain to start rising within the next year as market interest rates rise in response to inflation.

Chart #9 in the printable issue plots the level of the Consumer Price Index (or CPI) excluding energy on a logarithmic scale. Here we see how inflation by this measure has averaged just about exactly 2% per year over the past two decades. But note how the index jumps above trend in the past several months. The year-over-year rate has been boosted to a degree due to the dip in the level of the index in April and May of 2020, but that dip was fully reversed by August of last year. What we've seen in recent months is a “miniboom” in the CPI above and be-yond its long-term trend-line. As we explained in the April and May 2021 TRENDS issues, the inflation surge appears to be transient, caused by restarting the economy. Fortunately, the Fed governors agree and remain inordinately afraid to “pull the punchbowl,” this time around, after prematurely doing so too many times in the past. This tells us that monetary policy will favor extraordinarily strong economic growth until at least mid-2023.

As this high-level assessment shows, the U.S. economy has emerged from the Covid 19 pandemic primed to take advantage of the Deployment Phase of the Fifth (or Digital) Techno-Economic Revolution. The last time we were in this situation was after World War II when we entered the Deployment Phase of the Fourth (or Mass Production) Techno-Economic Revolution.

However, fully realizing the transformational possibilities of this techno-economic revolution is not inevitable. Actions we collectively take today, ranging from investing in human capital to enabling a surge of entrepreneurship to diffusing technology to companies of all sizes, should create a virtuous cycle of job growth, rising consumption, and productivity growth. Lessons from past recessions reveal that this is not only possible, but likely. However, as experts at the McKinsey Global Institute note, failure to act would deliver a tepid expansion, which would be little more than an extension of the techno-economic Transition Phase we experienced after the 2008 financial crisis.

What’s the bottom line?

Now that the economy is on track to full recovery, investors, consumers, policymakers and managers all have a stake in accelerating positive change and preventing a return to stagnation. The opportunity is waiting for us to seize it.

Given this trend, we offer the following forecasts for your consideration.

First, through at least 2024, profit margins will grow as companies harness the productivity-enhancing power of new technologies and business models. According to McKinsey & Company research, we can reasonably expect to put the productivity malaise that followed the Dot-Com crash behind us. Maturing technologies coupled with the reengineering forced on business by the pandemic have prepared many surviving firms to make big leaps in performance. The greatest opportunities involve using maturing technologies such as artificial intelligence, augmented reality and Software-as-a-Service to address new markets and make the available workforce as productive as possible.

Second, winning companies will seize opportunities created by the residual effects of behavioral adaptations which occurred during the pandemic. Some of these behavioral shifts such as working remotely and more e-commerce activity were well received by many people. Others like avoiding leisure travel, closed restaurants and minimizing in-person social activities, not only hurt many industries but were a real detriment to people’s well-being. For the most part, behaviors in the first category will remain, while those in the latter category will atrophy. 

Third, in the U.S. and the EU, about 40% of workers will work from home between one and five days per week from now on. These are mostly knowledge workers. Beginning this year, we’ll see companies deciding exactly who needs to return to the office and who can continue to work remotely. For most of this forty percent the payoff for both the firm and the worker leans toward working remotely, at least a few days every week. This will not only impact firms and household, but it will transform the market for both residential and office real estate. Businesses that serve these workers and their employers will also be impacted.

Fourth, the huge shift to eCommerce we saw in 2020 will slow, but not reverse. For most product categories, e-commerce is inherently more efficient than brick-and-mortar retailing. However, brick-and-mortar retailers are combining human-based services with experience-enhancing technologies like augmented reality to create an experience which is hard to replicate online. Therefore, the Trends editors expect e-commerce growth in the United States to slow from 4.6% last year to roughly 1.5% in 2022.

Fifth, over the next two decades the emerging era of “unleashed and broad-based demand” coupled with “accelerating innovation and dynamism” will create a prolonged period of renewed economic progress. Trends’ subscribers know this as the Deployment Phase of the Fifth Techno-economic Revolution. As highlighted by McKinsey & Company, the last similar period saw average growth of three times the “new normal” experienced during the Bush and Obama years or the era of “1970s Stagflation.” Why? Because rapidly rising productivity complemented a rapidly rising population. Technology has now reached a stage from which productivity can accelerate rapidly while artificial intelligence and robotics can substitute machines for slower growth in human capital. The end result will be per capita wealth growth beyond the 2.4% per year trend-line we’ve seen over the past 70 years. The challenge is to make sure that people outside the top economic quintile benefit from this coming windfall. Both the MAGA Agenda and the Green New Deal aspire to achieve this, but in totally different ways.

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