Financial markets thrived last year. All parts of the global economy – the United States, developed international markets, and emerging markets – shifted into high gear in 2017. Yet these economies have operated below potential for a prolonged period, due to anemic growth in supply and demand. Consequently, we see ample room for a sustained pickup in growth this year.

Things were not so rosy just couple of years ago. The European Union was heading toward possible disintegration, China’s growth was repressed by debt and some feared the U.S. economy was skirting deflation. Fortunately, Altfest took a relatively more constructive view at that time, especially about the markets outside the United States. Our contrarian investments have paid off well.

While we remain upbeat about international economies, the health of the U.S. economy is still predominant at shaping the global investment landscape. To gain a deeper appreciation of the dynamics at play, let’s take stock of the major actors that move our economy forward.

Consumers

Household consumption makes up about 69 percent of U.S. gross domestic product (15 percent of world GDP).¹ Put simply, U.S. consumers are a major driver of global economic activity. The Great Recession that began in late 2007 put an alarming brake on our consumption. U.S. households were forced to cut back spending to manage unsustainably high debt. As spending collapsed, over 8.5 million jobs were lost.² Fear had set in of a deflationary spiral – a vicious cycle in which lower spending reduces demand for goods and services, fueling unemployment and in turn decreasing spending further. Regulators and governments had to respond with extraordinary monetary and fiscal measures to fend off a calamity.

By late 2015, U.S. consumer balance sheets had stabilized.³ Consumer sentiment today is rivaled by only a handful of expansionary periods, such as the 1960s, 1990s and 2000s.⁴ Nevertheless, wage growth remains stubbornly low, holding back consumer demand and inflation.

Shareholders

Shareholders have been well-rewarded with robust returns after the financial crisis. In the post-crisis world, to cope with diminishing revenue prospects, companies had to emphasize cost discipline to boost profitability. Slow economic growth and labor market slack also encouraged firms to lower capital investments, inadvertently driving down productivity. Corporations instead used their record profits to pay back shareholders with share buybacks and dividends.

Looking forward, the same dynamics seem unlikely to continue. Monetary policy is on a path to gradual normalization, which likely will raise borrowing costs over time. Labor markets have started to tighten, which, in the absence of revenue growth, will pressure profitability. Capital expenditures to enhance productivity now appear imperative to sustain revenue growth and profits. The pivotal question for investors is whether productivity growth presages wage growth and inflation.

Workers

Labor markets have improved significantly from the deflationary scares of the Great Recession. Unemployment numbers already have reached lows seen during past expansions. Yet muted wage growth has resulted in a weak recovery. Although corporate profitability has been high, the share of national income going to the workforce has diminished.

A factor behind stagnant wages was a precipitous drop in corporate investments. The cutback on research and development spending between 2007 and 2009 was the largest since the 1960s.⁵ A widening skill gap exacerbated the problem, with qualified sidelined workers falling short of the number of job openings. A rise in populism ensued, reflecting the socioeconomic despair of individuals and communities being left behind amid a seemingly flourishing economy.

Governments, Central Banks and Regulators

In a well-functioning economy, the role of facilitators such as regulators, central banks and governments is important but limited. However, the financial crisis thrust them into a pre-eminent role. To stave off a 1929-style Depression, governments increased fiscal spending, while central banks engaged in quantitative easing: buying financial assets after having slashed interest rates to zero. The resulting asset-price inflation helped create wealth in the economy, stabilizing it and allowing recovery to take shape, as intended. The unintended consequence was mounting financial inequality.

With economic growth stabilizing worldwide, the cycle is slowly turning around. Monetary policy is expected to be less accommodative as the economy strengthens. As capital investments increase, the hope is that labors’ share of income will rise. Whether policies, such as the recent tax cuts, have the desired effect on the economy will be crucial for sustainable growth.

Implications for Altfest Investment Strategy:

Despite its duration, the U.S. economic recovery does not appear to have reached its cyclical peak. We have yet to experience the aggressive investment and excess capacity-building that typically accompany late cycles. After a long pause, a host of promising technologies are in the pipeline, which can fuel productivity growth. We have increased our investments in areas such as biotechnology, robotics and industrial automation, for example.

Although the U.S. economic outlook is strong, the troubles in Europe and China that caused market turmoil a couple of years ago are by no means fully resolved. Geopolitical unrest, in places such as in the Korean Peninsula and the Middle East, continues to emerge. In our assessment, risks from monetary-policy mistakes such as pre-emptive rate hikes seem low, but we prefer to be cautious as global policies approach a turning point. U.S. markets appear priced for perfection. Our investments in bonds and alternatives are designed to soften the impact of any downturns, should market expectations prove to be too lofty.

Sir John Templeton famously said, “Bull markets are born in pessimism, grow on skepticism, mature on optimism, and die in euphoria.” This bull market was born as an aftermath of the Great Recession – as the recovery transitions from skepticism to maturity, prudent risk management will drive investment performance.

 

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References:  ¹World bank, U.S. Bureau of Economic Analysis, U.S. Bureau of Labor Statistics;  ²Bureau of Labor Statistics;  ³Household Debt to GDP for United States, Federal Reserve Bank of St. Louis, International Monetary Fund;  ⁴Survey of Consumers, University of Michigan; ⁵The Lasting Damage from the Financial Crisis to U.S. Productivity, Redmond, Van Zandweghe, Federal Reserve Bank of Kansas City

Note: All numbers are approximations

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Sush Poddar is an Investment Strategist at Altfest. Prior to joining Altfest, she was an Executive Director at a large investment bank, where she spent a decade as a Trading Desk Strategist. She holds an MBA in International Finance from Thunderbird School of Global Management at Arizona State University and a Bachelor’s degree in Computer Science & Engineering from Osmania University, India.

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Investment advisory services provided by Altfest Personal Wealth Management (“APWM”). All written content on this site is for information purposes only. Opinions expressed herein are solely those of APWM, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation. All investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.