Financial Insights

This Economic Recovery Has Been Stronger Than You Think…and May Have Further to Go

GDP growth is one of the most popular ways to measure economic growth, but isn’t necessarily the best. The rate of net job growth is a far more effective way of measuring economic performance over the course of the recovery following the recession, and looked at in this way, this recovery has actually been rather solid and consistent, even relentless.

graph

All US recessions from post WWII until today

Modern recessionary and expansionary periods are far longer, wider, and slower moving than in the past. The past 3 recessions look like wide “U” shaped curves compared to the very sharp “V” recessions from the 1950s and 1960s.  Modern recessions and job losses take time to manifest and happen gradually. So do the recoveries. Indeed, of the past 4 recessions, we’ve had 3 of the longest recoveries in the history of this data being collected.

The cause of this change is that our economy has evolved from a manufacturing economy to a service based one. In the 1950s, when automobile demand dropped, inventories built excessively and there was no way to reduce the excess supply without shutting down plants and laying off mass numbers of workers temporarily. The entire assembly line was either employed or not. Once inventories fell to normal, workers would be brought back from their furloughs, adding income and spending back into the economy, which promoted recovery.  These inventory recessions saw steep declines in activity followed by comparably rapid rebounds.

In the service sector, using hotels as an example, when a hotel’s business slows, the owner can respond very gradually and progressively. If the occupancy rate drops slightly the hotel can terminate one person. The same is true as things improve so the entire process is gradual.  Moreover, the inventory excess lies in the personnel count and it is not even obvious those people can or should be rehired.  The firm doesn’t know when business might pick up again.  So, service firms don’t lay off workers.  They fire them.  And if demand continues to erode, they fire another round of workers, adjusting costs gradually to the lower level of sales.  The same process happens to retail firms or other service operators.

If the 2008 recovery is viewed within this context, it suddenly doesn’t look like such a slow recovery. No doubt the 2008 recession was incredibly deep.  In fact it was the deepest recession since 1948 in terms of the percentage of job losses relative to peak employment. But the rate of the recovery has been almost identical to the last recession in 2001 and the one prior in 1990 and we don’t think of either of those recoveries as particularly slow. Job improvement has been exactly on par with previous recoveries.

The performance of GDP growth is an entirely different story. Population growth is slower than most of the post-World War II period. At the same time, productivity gains have also slowed significantly. So, potential GDP growth has slowed.  Even so, population growth doesn’t determine the unemployment rate, nor does productivity improvement.  That is determined by total demand relative to total output.  Today, the unemployment rate sits at a very healthy 4.8%. This is lower than 85% of history since 1971 and this is a much better snapshot of current economic health than GDP growth.

So, what does this analysis imply about Fed policy?  If the economy is actually performing well, as implied by the solid, persistent growth in employment and the decline in unemployment to 4.8%, then it is entirely appropriate for the Fed to normalize interest rates.  As suggested by another Bloomberg View article by my father, the Fed is actually behind the curve in bringing policy back towards neutral.  Four interest rate hikes in 2017 remain our best guess for 2017.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.

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