State of the Markets
The third quarter of 2015 was beset with concerns about slowing global growth as investors continued to digest information about the Chinese economy, the strength of the U.S. dollar, the decline in oil prices, and slowing corporate profits. An environment such as this is generally good for bonds and bad for stocks, which is exactly what played out.
The quarter began with continued pressure on a variety of growth oriented asset classes (stocks, real estate, energy & infrastructure). By mid-August, the concerns described above intensified and stock markets suffered a fairly rapid and steep correction, falling more than 10% from previous highs. After rebounding some in September, equity markets retreated once again as the Federal Reserve decided to leave rates unchanged, reinforcing concerns about slowing growth.
The total returns for major asset classes are below.
Yes, this was a bad quarter, but this correction is well within our expectations.
As you can see in the chart below, there have been many blips on the radar of this long, multi-year bull market. Each one was a reaction to concerns similar to the ones described above, yet none of these corrections resulted in more than a temporary setback.
The good news is that diversification is working as bonds (as measured by the Barclays Aggregate Bond Index) had a positive performance in the face of a declining stock market.
4% Growth – Economic Possibility or illusion
The political primaries for the 2016 Presidential election are in full swing and with them come much debate about government policy. One of the problems getting a lot of attention is the relatively slow growth of our economy. Many candidates have a solution for slow growth and some have even proclaimed their policies will easily take us to 4% growth. Voilà! If it were only that easy.
The reality is that sustainable 4% gross domestic product (GDP) growth has never been achieved in our country’s recent history. There have been many individual quarters with GDP growth higher than 4% but the long-term average is certainly closer to 3%. (There are many ways to measure GDP growth, so being specific here is not important.)
For background, GDP is an aggregate measure of what we produce as a nation - our economic output. GDP growth, which is the headline number reported on a quarterly basis, is a measure of the change in that output. This is important because at the end at the day we get to consume what we produce, so the higher our output, the higher our standard of living.
Given this, a back of the envelope way to view increases in GDP is to think in terms of increases in the number of workers and increases in how much each worker produces. Historically, productivity gains (output per worker) and the growth in workers have averaged around 1.5% each per year, which lines up nicely with the historical growth in GDP. This is illustrated in the chart below.
Unfortunately, also evident in the chart, is the fact that both of these measures have fallen below our long-term trends in the last decade. Annual productivity growth has declined to 1% over the last decade and annual growth in the workforce has declined to 0.5%.
The decline in workforce (a trend which is likely to continue) can easily be attributed to retiring baby-boomers and disenfranchised workers dropping out of the labor pool. The decline in productivity is harder to pinpoint but I would bet a good portion is the result of inefficient regulation, a lack of corporate investment, and our economy’s continuing shift away from manufacturing towards services.
By inverting the reasons for slowing growth, we can gain insight into what changes would likely result in higher growth. As a nation, we should be implementing policies that increase our workforce and increase our productivity. Several to consider:
- Intelligent regulation that allows businesses to operate efficiently while still protecting the environment and consumers
- Corporate tax reform that lowers the corporate tax rate, eliminates special interest loopholes, and incentivizes corporations to bring foreign earnings back to the U.S. without excessive financial penalty
- Policies that encourage domestic manufacturing
- Immigration policies that allow young, productive foreigners who want to become tax paying Americans the opportunity to do so
This is not meant to be political commentary as much as general observations about which policy changes would likely have the most beneficial impact on our economy.
Third quarter performance was not pretty, but equity markets have staged a significant comeback since the end of the quarter. While there is no guarantee the current situation won’t get worse before it gets better, we do have confidence in our plans and our portfolios.
As always, thank you for your trust and confidence.