economic perspective

June 2017


While the financial markets in the United States continued their overall upward trend through the first five months of 2017, domestic economic growth remains generally uneven and slow going. Thomas Dillman, President of Mutual of America Capital Management LLC, explores the structural drivers of the U.S. economy, examines the impact of consumer spending and weighs in on how long the current economic cycle can last.

What's Driving U.S. Markets Higher?

Through May of this year, all domestic markets except the Russell 2000® Value Index are in positive territory. The S&P 500® is up nearly 9% on a total return basis and is at all-time highs. The Russell Midcap® Index is up over 6% on a price basis, while the Russell 2000® Small Cap Index is up about 1.5%, primarily because of the drag from the value component. In fact, all value indexes are underperforming growth indexes across all market cap segments – namely, large, midcap and small. As noted in our April Economic Perspective, growth stock outperformance is generally indicative of investor concern about the sustainability of returns, because they seek greater relative stability among stocks in which earnings growth is deemed more secure versus value stocks.

Despite most U.S. markets hitting new highs, there is a degree of caution and skepticism among investors. One glaring example supporting this notion is that about half the returns of the S&P 500® this year have come from five stocks: Apple, Amazon, Facebook, Google and Netflix. The technology sector of the S&P 500® is up 20% year-to-date, almost twice as much as any of the other sectors. Moreover, its weighting in the index and, therefore, its impact on overall index returns, is currently nearly 25% – again twice as much as any other sector. The fact that technology has provided such a significant part of the S&P 500®'s total return suggests the strength of the markets is not particularly broad.

Another indication of investor cautiousness is the characteristics of those stocks performing the best. These include: stocks whose companies have high-quality fundamentals, such as high measures of return on equity and low leverage; stocks whose prices are less volatile while at the same time showing heightened responsiveness to market movements; and stocks ranked high on growth factors and low on value factors, as supported by the relative performance of growth indexes versus value indexes, as mentioned above. The best performing stocks tend to have high price-to-earnings ratios, a characteristic that typically attends growth and quality characteristics. Investors have gravitated to stocks that provide, at least at the moment, the assurance of stability and growth as opposed to low-value, higher-risk stocks that do well during periods of improving fundamentals and stock price momentum.

Key Foreign Markets Strong Year-to-Date

Most foreign markets are either in line with or outperforming U.S. markets. According to MSCI Inc. stock price return data year-to-date, Europe is up 14.5%, China is up 10%, the developed markets of the Pacific region are up 8.3% and emerging markets are up 16.6%. By contrast, and not surprisingly given the turmoil throughout the region, nearly all Middle Eastern markets are down, but only modestly. The regions outperforming the U.S. markets are demonstrating accelerating economic growth compared with that of the U.S. economy, which continues to oscillate around its average of 2% since the 2008 Great Recession. It is true that first quarter S&P 500® sales and earnings were among the strongest in years, but the year-over-year comparison was against depressed levels.

Structural Drivers of the U.S. Economy

In our opinion, the U.S. economy is likely to continue to grow at around a 2% rate into the foreseeable future. The normal structural drivers of the 3% rate that is claimed to be the longer-term average of our economy are no longer present. Population growth during the 1970s and '90s was bolstered by immigration, largely from Mexico, adding about 1% to population growth. During this century, Mexican immigration has flattened as economic opportunities diminished in response to two recessions. In addition, an increase in anti-immigrant sentiments in the U.S. has further impacted immigration growth.

Another structural driver of growth is productivity – a measure of output per input of labor – which has ratcheted down over the past 10 to 15 years. This means that if the production of one widget requires one hour of labor, the addition of another hour of labor produces less than two widgets. One explanation for this decline in incremental productivity is that as older, more experienced workers retire, they are being replaced in general by younger, less experienced workers who do not have the skill levels to produce at the higher rates of those they replace. Over the past 30 years, the average of measured productivity was around 2%, but has almost consistently declined over successively shorter periods. For instance, over the past 15, 10 and 5 years, productivity registered at 1.6%, 1.3% and 0.6%, respectively.1

A related structural impediment to U.S. growth looking ahead is the greater rate of retiring workers versus the numbers of younger workers entering the workforce. This has been the case for some time now. As suggested above, this may partially account for the decline in labor productivity. However, the so-called Millennial generation (18–34 year olds) recently surpassed in number the population of living Baby Boomers (those born between 1946 and '64). As more Millennials enter the workforce and develop greater skills, there is hope that productivity may begin to improve.

However, as a result of the increased substitution of capital for labor in the form of technology –for example, robotics in the factory and online retailing and advertising – the number of available jobs is likely to decrease, and the jobs created are likely to be lower-skill and lower-compensation jobs.

The Dollars and Cents of Growth

All these various structural but interrelated headwinds to long-term growth raise many other questions, all summarized by the following question: Who will pay for the costs of living for U.S. citizens if wages and salaries remain stagnant, productivity remains muted and the demand of rising social costs – such as retirement, health care and infrastructure – continue to climb? To put this in dollars and cents terms, the difference between 3% growth and 2% growth over 10 years is $3.4 trillion, while over 30 years the gap is $12.3 trillion, based on a current total output of about $20 trillion.1 With stagnant incomes, taxes are unlikely to make up the difference. The only conceivable source of money to fill the growing gap is government borrowing. The ratio of government debt to Gross Domestic Product (GDP) in the U.S. is currently about 105%, while total debt, including household and corporate debt, is over 275%.2 Those strategists and economists looking for a bubble have no further to look than such statistics. Politicians will have to concern themselves less with maintaining their jobs than addressing these long-term issues before the impending crisis is upon us. That means addressing tough spending and tax issues such as Social Security, Medicare and Medicaid, and tax reform.

The good news is that, in the near term, economies around the world are, in general, healthy and growing. The International Monetary Fund has just raised its expected global growth rate from 2.7% to 2.9% for 2018, aided by an accelerating recovery in Europe, Japan and the U.S. China is the weak link and poses the most risks to the global economy because of extremely high debt levels that continue to grow. The hope is that China's managed economy has the levers necessary to maintain relative stability and continued growth, even if it is decelerating.

The U.S. Consumer Is Spending

Regarding the U.S., recent statistics have been generally solid, but still not indicative of a major pick-up in growth. The key to the U.S. economy is the American consumer. Consumption represents two-thirds of GDP; consumer spending is crucial to the trajectory of growth. Importantly, consumers continue to spend, and without excessive borrowing. The savings rate remains relatively high at over 5%, while credit card debt and bank loans have increased modestly, and yet the consumer has maintained spending growth at around 2.5% throughout the expansion. Admittedly, there are some concerns over rising subprime lending in the auto market and extremely high outstanding education loans, with both showing rising delinquency rates. But at this point, these issues do not appear out of control. In short, a solid U.S. consumer provides a solid base for continued modest growth.

The other components of GDP have proven less stable. Capital spending has remained generally weak throughout the expansion, net exports have been a drag as dollar strength has been a drag on exports but a plus for imports. The result is a flat to increasing trade deficit. Government spending only recently began to pick up, although spending initiatives of the Trump administration could, if implemented, make government spending a positive contributor to growth.

How Long Can This Economic Cycle Last?

One issue that comes up often among economists and strategists is the question of how long this economic cycle can persist before entering recession. The current expansion has just hit the eight-year mark. The longest cycle in postwar history occurred during the 1990s and lasted nine-and-a-half years from trough to peak. It is always dangerous to claim that "this time is different," but there are a number of arguments that suggest that it is and that this cycle could last a lot longer. The first is that growth remains muted and, as suggested earlier, is likely to remain so. Economic cycles end in recessions, which are generally accompanied by excesses of one sort or another. The recession of 1980–81 resulted from the sudden and dramatic increase in the Federal Funds rate by Paul Volcker, Chairman of the Federal Reserve at the time, in response to nearly a decade of runaway, double-digit inflation. The recession of 2000–01 followed the tech bubble blow-off, and the 2008–09 recession followed the subprime lending crisis. The only potential excess in the U.S. at present might be the stretched valuations in the stock market, which seems to be discounting the current administration's proposed tax reform and infrastructure initiatives – both of which are increasingly likely to be pushed out in time and reduced in scope even if they could muster the required votes in Congress.

It must be said that the Democrats' unwillingness to support any of President Trump's proposals in their current form; the proliferation of investigations into his and his associates' alleged involvement, if not collusion, with Russia during and after the election, including a possible charge of obstruction of justice against Trump himself; and the general disarray and confusion that attends almost every daily White House proceeding portends at least some continued congressional gridlock and, at worst, a constitutional crisis that involves possible impeachment.

Surprisingly, but not unprecedentedly, none of this so far has derailed the economy or the stock market. During the Watergate hearings and subsequent resignation of President Nixon, the U.S. did suffer a recession and a bear market, but more for economic than political reasons. The U.S. economy had expanded for four years at an average annualized basis of 3.1%. Accompanying this sustained high rate of real growth was an extended period of out-of-control inflation resulting from increased social (i.e., Medicare and Medicaid) and defense (i.e., Vietnam) spending during the late 1960s and early '70s. Then, in October 1973, in response to U.S. support for Israel during the Yom Kippur War, OPEC instituted an embargo on oil exports to the U.S. and its allies that quadrupled the price of oil and eventually contributed to a deep recession and market decline of more than 40% in 1973–74. In contrast, both GDP and stock prices continued to advance strongly throughout the Clinton-Lewinsky affair, including President Clinton's impeachment trial in Congress.

As we've repeatedly stated in the past, stock prices are determined largely by economic growth. At the moment, the U.S. and the global economy appear on solid footing, even if not at a gangbuster pace. In our opinion, an extended cycle at an average annualized growth rate of 2% without recession would be preferable to the normal wrenching ups-and-downs of economic growth and stock prices. Remember the tortoise.


Mutual of America Capital Management LLC.


Economic Research, Federal Reserve Bank of St. Louis, October 1, 2016.

The views expressed in this article are subject to change at any time based on market and other conditions and should not be construed as a recommendation. This article contains forward-looking statements, which speak only as of the date they were made and involve risks and uncertainties that could cause actual results to differ materially from those expressed herein. Readers are cautioned not to rely on our forward-looking statements.

Mutual of America Capital Management LLC is an indirect, wholly owned subsidiary of Mutual of America Life Insurance Company. Mutual of America Life Insurance Company is a registered Broker-Dealer.

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