At my November monthly economic and market webinar for Advisor4Advisors, attendees asked a number of questions that we did not have time to answer. Thanks for your thoughtful questions. See my answers below.
What type of indicators or data would you be focusing on to make you a bit MORE cautious about the US stock market? An earnings slide? Substantially higher 10-year US bond? Spike in inflation?
The main thing that could make me more cautious on stocks would be obvious deterioration in the key economic data – the monthly ISM purchasing managers surveys, the index(es) of leading economic indicators and the employment numbers, both weekly unemployment insurance claims and the monthly new jobs report. And, yes, if we started to see ominous signs pointing to higher inflation, it would be a big negative. Rising bond yields, no—as I point out in the charts. Rising bond yields have been entirely consistent with rising stock prices.
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When will business investment pick-up? Are businesses still sitting on piles of cash?
True, businesses are sitting on piles of cash and their ability to borrow cheaply has rarely been stronger. In the following chart, see how business investment in plant, equipment and inventories contributed a total of +1.0% to the third quarter’s +2.8% total GDP growth. Not bad considering that business investment constitutes only about 6% of the total GDP. The post-recession pattern of business investment actually looks pretty typical to me. Significantly weak post-recession business investment, I think, is something of a myth.
In my opinion, lower-range GDP growth is largely due to repressive fiscal policy in Washington DC, i.e. higher taxes, regulations, etc. You seem to disagree, correct?
No disagreement from me. In the equation ∆ GDP = ∆ productivity + ∆ labor force, these are factors that work significantly against productivity gains, the key driver of GDP growth that I was discussing. So, for example, if a company has to hire one additional employee in order to cope with increased government regulation (filing forms, etc.), then that company’s output per employee suffers. Similarly, higher taxes take away from a company’s ability to purchase additional productivity-enhancing equipment, denying the company a means to improve output per employee.
On slide 25 (below), the pattern is very erratic. Does you expect it to smooth out as illustrated. Or will it continue to have more dramatic moves?
I assume the reference to page 25 refers to the long-term volatility in actual year/year GDP growth. No, I do not expect this pattern to change in the future. The U.S. will undoubtedly continue to experience a great deal of cyclicality in its economy for the foreseeable future. The flat squiggly line that I inserted as a “forecast” for GDP growth is simply an illustration of Prof. Gordon’s forecast for a trend rate of growth in the years ahead.
Won't proposed lowering of corporate taxes also add to higher profit margins in the future if Congress changes the tax on corporations?
Yes, they might. I say “might” because it would depend on whether lower tax rates actually result in lower corporate taxes paid. Congress might couple lower tax rates with the elimination of the many deductions (“loopholes”) that companies can currently claim.
According to the Bureau of Labor Statistics, the percentage of Americans over age 16 who have a job or are actively seeking one fell to a new 35-year low in October at 62.8%. With the labor participation rate as low as it's been historically, and with the real unemployment rate in the low double-digits when factoring in those working part-time who want full-time work and those who have simply dropped out of the workforce, is this a worrisome picture—even moreso as Obamacare works its way through the system and has led to lots of shifts in payrolls already such as retailers, leisure and hospitality, etc?
The decline in the labor force participation rate that you describe is a function of both the slow cyclical recovery from recession and secular changes in Americans’ propensity to get a job and go to work. The participation rate peaked at 67.3% in 2000 and started rolling over well before the last recession. The October figure is 62.8% as you point out. The historical context is important and I think the secular drivers of a declining participation rate are a part the story here and there’s really nothing much we can do to change them. If bad policy is contributing to lack of hiring, that is worrisome. However, I have great faith in our system to correct course which it very well might do with respect to Obamacare specifically.
Doesn’t the BNP Paribas study about active managers suffer from survivorship bias?
I referred to the FundQuest BNP Paribas Group study dated June 2010 in making the point that an appropriate application of Modern Portfolio Theory might include actively-managed funds in addition to indexed funds and ETFs. Whether or not the study suffers from survivor bias, I do not know. However, even if it does, and based on my own observations, my point is that in some asset categories there do exist actively-managed funds that have consistently beaten their index benchmark and, therefore, might deserve consideration in an asset allocation strategy. In some categories these outperformers might be small in number, indeed, or even non-existent. Whereas generally I believe that index products are probably the optimal solution, I do not believe that indexing, everywhere and always, is the superior strategy. Particularly in less-efficient parts of the global markets, or when it comes to alternative strategies, active management in some cases might prove to be superior to the index.