Fireside chat with Don Rissmiller
This morning the Monarchians had the pleasure of hosting Don Rissmiller, chief economist of Strategas, in our offices. Our relationship with Strategas goes back more than 4 years, and we have the luxury of at least 1 of their 5 analysts (as well as Jason Trennert) visiting us every year.
We wanted to share some of the highlights of our talk with Don, and a couple of his favorite charts. His main thesis points about the economy right now are:
- The U.S. economy can’t fall much from its current levels, as we have pointed out lately, given the low levels of employment, new home construction, and auto sales, among others.
- The gap between economic output (GDP) and employment can’t hardly get any wider. We will elaborate on this point below.
- The 1950s might be a valid comparison for our economy in the next decade. Strategas believes it will feature shorter business cycles, and thus more frequent, though less damaging, recessions.
- The reason for shorter business cycles is that our economy can no longer rely on the cushion of consumer spending, which in the past has been used to engineer soft landings. Also, see below.
- We are now officially in an era of “financial repression,” by which the government keeps interest rates low, primarily so it can reduce its debt. The repressed are savers, who are no longer earning a credible rate of return on safe assets. Also, see below.
- Cash on corporate balance sheets can no longer wholly be called “capital” because capital is defined as assets that are used to generate profitable returns. Some high % of today’s cash on balance sheets is simply hoarded cash that is still waiting to be put to work. Why is this still going on? Don rightly points out that a company could be considered reckless by making a large investment now, prior to (potentially) significant tax reform in the coming months. Let alone changes in the regulatory landscape, the possibility of a financial crisis in Europe, a global economic slowdown, potential changes in the composition of Washington, etc.
- Comparisons to the 1930s need to be addressed in terms of the mistakes made then in trying to stimulate job growth: monetary policy, fiscal policy, trade policy, and regulatory policy. Government made mistakes on all 4 in the 1930s. Don rates today’s policymakers, on balance, as much better than in the Depression. Monetary policy has been extremely accommodative, fiscal policy is debatable, trade policy good, and regulatory policy as the only one in the “mistakes” category. However, on trade policy, attention needs to be paid to the China currency bill gathering steam in Congress. This would be the first major mistake on trade in this recovery.
GDP <–> Employment
As the chart below shows, GDP and employment historically travel together, which makes sense. Never before have they so wildly digressed as in the last 3 years. Our economy is now producing as much stuff as in 2008, but with 7 million fewer workers. Another way of showing this is that employment bottomed out in early 2010 at a lower level than in 2003 (blue bars), while real GDP bottomed out at a 10% higher level (red line):
Don believes this is unsustainable, and the gap will most likely close with higher employment, at some point. While this might seem overly optimistic today, remember that any increase in demand probably requires some increase in employment given how stretched the work force is. This could potentially result in wage inflation at some point, which would start the countdown to recession.
Consumer spending has risen from 61-64% of our economy in the 1950s, 1960s, and 1970s, to 71% of our economy now. There have been big benefits from this rise. First, consumer spending is less cyclical than other GDP contributors, such as business spending, commercial real estate, and exports. Second, consumers have proven to be a reliable cushion to economic slowdowns, and malleable material in the hands of the Fed. The old playbook of softening economy -> Fed cuts rates -> consumers borrow money -> consumers spend more money has worked so many times since 1980. It helped our economy avoid recessions in 1985, 1995, and 1998, and helped mitigate the depth of every recession since 1980. However, the mechanism for this magical chain of events has typically been housing, which is now semi-impaired at best. Housing will be back in future economic cycles, but for now, it won’t allow consumer spending to be a cushion against recessions anymore. Thus, Strategas believes we will see shorter expansions, and more frequent recessions. The chart below shows 3 recessions between 1954 and 1960. This isn’t necessarily bad for stocks, which rose 347% in the 1950s.
Strategas has been talking about this being “an era of financial repression.” This is a very obtuse concept, but it loosely means that real interest rates can be held down at low levels by the government as it pays down debt. Who is being repressed? Savers. Anyone who wants to earn a decent return on safe assets is being told to come back another day. With the 10-year treasury bond yield below inflation (CPI), this means that the bondholder is earning a negative real return. The government would prefer you take your excess deposits out of the bank and take some risk on something else, like stocks.
As the chart below shows, this also happened in the 1970s, when inflation exceeded bond yields for much of the 1974-80 period.
The bottom line is that there are certainly hurdles for our economy in the next few years–no surprise there. Looking out longer-term, our economy needs to take care of those hurdles, and all the regular blocking and tackling (keep having kids, welcoming immigrants, and increasing productivity) in order to keep our growth trajectory intact. That’s the subject of our newsletter this quarter, which we sent out Monday.
In the stock market, all eyes continue to be on Europe. Everyday’s action in the market is essentially dictated by who said what in Europe. Amazingly, U.S. economic data in the last 2 months has held up fairly well. The market had assumed we would have seen severe deterioration, thanks to the chicken fight in Washington, the stagnation of our economy in the first half of 2011, and the subsequent 20% stock market correction. While we would have guessed the good data to be a boon for stocks, it has merely allowed investors to hang in there until there is resolution in Europe.