When looking at various projections for real U.S. GDP growth in 2012 and 2013, one is struck by the degree to which forecasters seem wedded to the textbook definition of a 'normal' growth rate. That is, as the events of 2008 fade into history, estimates for U.S. real GDP growth are gravitating back toward the historical average rate of around 3%.
While this certainly makes some measure of sense -- averages tell us something important about the past and help inform our expectations about the future -- estimates of future growth should reflect a realistic assessment of what the environment is likely to look like going forward and should not be rooted too firmly in past experience. After all, the circumstances that conspired to produce the growth rates of the past are markedly different from the circumstances that exist today.
Even with the looming fiscal cliff, depressed capital spending, and the ongoing crisis in the eurozone however, consensus estimates for real U.S. GDP growth in 2013 are still around 2%. Some have the figure far higher. Goldman Sachs for instance has the U.S. economy growing at 2.3% in 2013 and 2.5% in 2014.
What isn't clear is whether these figures are realistic in the post-crisis environment. Some analysts have recently suggested that demographic changes and a fundamental shift in corporate philosophy have conspired to make it impossible for the U.S. to grow at a rate consistent with the growth rates of the past. For example, Jeremy Grantham, co-founder of GMO, suggests that population growth in the U.S. will continue to slow, and will average just .5% per year over the next two decades. Furthermore, Grantham expects hours per worker to decline over the same period. According to Grantham, the combination of these two factors will constrain productivity, weighing on GDP growth.
Perhaps the larger issue however is the slump in capital spending; this is something Grantham also mentions as a factor in explaining why investors should only expect U.S. real GDP growth to average .9% going forward. Depressed capex has become somewhat of a hot topic these days but rarely is it explained exactly why, at the root level, it is such a problem.
Obviously, decreased capital spending across the board takes a bite out of top-line growth. However, the absence of spending on capital goods creates a deeper problem.
Because the employment rate cannot go up forever (eventually, everyone in the labor force will have a job), more output must be squeezed from each worker (productivity must increase) if GDP is to continue to rise after full employment is reached. By the same token, when employers are unwilling to hire more workers for whatever reason, the only way output can increase is if each worker is more productive. For instance, between 1992 and 2010, hours worked increased by just 10% while total output rose by seven times that amount.
Any standard economics text will tell you that this increase in productivity per worker is a key component to rising per capita GDP. In turn, rising per capita GDP determines whether living standards continue to post gains or begin to deteriorate. Capital investment is a major determinant of worker productivity. With new and improved equipment, each worker can produce more in the same amount of time. If capital investment flatlines as it has currently, productivity gains will disappear. From Grantham:
...obviously you embed new technologies and new potential productivity more slowly if you have less new equipment.
In fact, as the stock of capital ages, productivity may actually decline, causing output to shrink and living standards to fall. If depressed capital spending is to be the chosen method for boosting earnings going forward (companies can buy back their own shares with the money they save, reducing the number of shares outstanding, thus boosting EPS, something Grantham calls, "The Bonus Culture"), expect economic growth to suffer accordingly. Here's Grantham again:
[Sacrifice capital spending for share buy backs] enough, though, and we will begin to see disappointing top-line revenues and a slower growing general economy, such as we may be seeing right now.
To drive the point home further, consider the following chart, which shows that the average growth in U.S. labor productivity has fallen off markedly since 2004, and is well below the historical average:
Source: Robert Gordon
Grantham's letter cites a paper by Professor Robert J. Gordon of Northwestern University, which has received quite a bit of attention lately. The paper, entitled "Is U.S. Economic Growth Over?", notes that the growth rate of real GDP per capita in the U.S. has begun to fall. Gordon even goes so far as to suggest that it will eventually fall back to the level (.2%) the world experienced for centuries before 1700:
Source: Robert Gordon
Consistent with the idea put forth above (that the new reality is not compatible with 3% GDP growth in the U.S.), Gordon notes that,
...economic growth has been regarded as a continuous process that will persist forever. But there was virtually no economic growth before 1750, suggesting that the rapid progress made over the past 250 years could well be a unique episode in human history rather than a guarantee of endless future advance at the same rate. (emphasis mine)
Indeed the U.S. economy may only be growing today due to successive bailouts and programs implemented to keep the financial system from collapsing. While the headline figures regarding emergency measures typically only include QE1, QE2, projections for QE3, and perhaps TARP, the sum total of money printed to rescue the system is over $32 trillion:
As Lance Roberts of StreetTalkLive notes,
...it took injecting nearly half of the worlds current GDP into the financial system to offset the drag of the financial crisis, modestly boost employment and keep economic growth only slightly above flat line.
Of course, we cannot continue to spend half the world's GDP on bailouts and assistance programs in order to keep the economy growing at 2-3%. It could simply be that the U.S. will have to become accustomed to lower GDP growth in the future as the environment is simply no longer conducive to producing the steady growth Americans enjoyed in the past. In fact, a simple chart showing GDP growth by decade seems to confirm this:
Investors should keep these considerations in mind when making investments for the long term. If sluggish growth is the new norm and the issue is exacerbated by companies' short-sighted pursuit of buyback-fueled EPS gains at the expense of capital investment, investors can expect that not only will U.S. stocks underperform going forward, but Americans' standard of living will fall as well. Expect these trends to reinforce each other and lead to sub-par returns. Accordingly, steer clear of U.S. equities and use recent strength to exit existing positions. For those looking to take full advantage of lower trending growth, long put options (LEAPS) on the S&P 500 (SPY) or Nasdaq (QQQ) may make sense. The key thing to keep in mind is that the new normal will not be as kind to U.S. stocks as the old normal was.