Trends In GDP, 10-Year Yield And Compensation

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 |  Includes: DTYL, DTYS, GOVT, PLW, TYD, TYO
by: Pat Stout

Summary

Trend in government spending as a percentage of GDP.

Rate of GDP change versus change in compensation and the 10-year yield.

10-year yield versus CPI and compensation.

Key takeaway and interest rate outlook.

Government spending as a percentage of Gross Domestic Product [GDP] has fallen from 19.7% in 1Q2012 to 18.2% during 4Q2013. The more recent quarter experienced a slight up-tick to 18.3%. Government spending has declined during 5 out of 6 quarters, totaling $76.5 billion. The cost control seen in government spending is an encouraging sign, as it leaves more income in the hands of taxpayers.

The pace of decline in government spending year-over-year has slowed from a 175 basis point headwind 3Q2103 to a more modest 23 basis point headwind 1Q2014. See the table below.

Year-over-year GDP slowed to 2.91% in 1Q2014 from 4.08% during 4Q2013.

Quarter

GDP

(billions)

Y/Y

% Chg.

Govt.

(billions)

Y/Y

% Chg.

Govt.

%

GDP

1Q2014

17,016.0

2.91%

3,117.0

-0.23%

18.3%

4Q2013

17,089.6

4.08%

3,118.4

-1.03%

18.2%

3Q2013

16,912.9

3.40%

3,137.5

-1.75%

18.6%

2Q2013

16,661.0

3.10%

3,121.9

-1.33%

18.7%

1Q2103

16,535.3

3.08%

3,124.1

-1.13%

18.9%

4Q2012

16,420.3

3,150.7

19.2%

3Q2012

16,356.0

3,193.5

19.5%

2Q2012

16,160.4

3,164.1

19.6%

1Q2012

16,041.6

3,159.7

19.7%

Click to enlarge

Source data: BEA

Some in the financial markets worry about inflation. Having experienced the ravages of inflation during the 1970s and 1980s, the fear is ingrained in one's awareness. The following charts might help quell the fear of a rapid pickup in the pace of inflation and/or the 10-year yield.

GDP versus 10-Year Yield

Gross domestic product and the 10-year yield have moved in a similar fashion. The pace of economic growth increased from the 1960s to 1980, with inflation and interest rates moving higher. Since 1980, the pace of economic growth has decelerated, as has the pace of inflation and the 10-year yield.

During the 1950s and 1960s, the yearly change in GDP growth generally exceeded the 10-year yield.

GDP versus Compensation

The yearly change of Gross Domestic Product and compensation has a long and tight relationship with the yearly change in employee compensation. The trend was upward from the 1950s to the 1970s, and since 1980, the trend has been lower.

10-Year versus Compensation

The pace of employee compensation generally exceeded the 10-year yield from the 1950s to the 1970s. Since 1980, the pace of employee compensation has generally lagged the 10-year yield. This may account for the subdued inflation.

10-Year versus CPI

Notice that the pace of inflation and interest rates headed higher from the 1960s to 1980, and then reversed direction and headed lower. Investors in the 10-year US Treasury have enjoyed attractive real returns (interest earned less inflation) since 1980.

Key takeaways

It is tough to see a spike or pickup of inflationary pressures without a pickup in compensation. A pickup in compensation could suggest a pickup in economic growth. However, given the slack in the labor force and the falling participation rate, the prospect for demand-pull inflation is minor compared to the possibility of cost-push inflationary pressure at the current time.

The outlook for interest rates depends upon the economic progress. Currently, the 10-year yield is suggesting the odds of a sharp and prolonged pickup to economic growth is not expected. The bond market may be locked in a prolonged trading range of plus or minus 20bps (basis points).

Investors that are worried about the stock market hitting new highs may wish to remember that the stock market entered the year at a record high. Thus, any improvement would require a new high. Moreover, during the Great Depression, the firms that survived were profitable!

The charts tend to suggest that something major changed in the 1980s. There was a renewed focus upon cost control; this resulted in the consolidation of vendors and a trend toward a single-source supply chain. Looking back at the economic growth generated, it might be argued that the pace of economic growth declined, in part due to the focus upon cost control and the increased use of debt. Many firms added massive amounts of debt; General Electric is one firm that comes to mind. GE shareholders over the past 15 years have borne the burden of the massive debt service, while the prior owners enjoyed the cash from the massive share repurchases.

The way I view things, it will be tough for demand-pull inflation to gain a foothold without a pickup in the labor participation rate and employee compensation. The revised GDP report showed a marked decline in the rate of healthcare spending. Therefore, the worry of a cost-push inflation issue from the Affordable Care Act is not seen in the current numbers. The increased mileage per gallon of autos and the new electric and hybrid vehicles may mute the effect of increased energy costs.

Bottom line

Without a pickup in inflation, what could drive the yield on the 10-year higher? Many world bond markets enjoy interest rates around the US Treasury rate, and Japan has seen decades of low interest rates without producing inflation.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.