Economic Outlook: 2015 Could Bring More of the Same
We may likely be entering a period of slower growth, but no growth at all is unlikely.
With this report, we are updating our 2014 economic forecast and rolling out our first guess at 2015. The overall GDP growth in 2015 will likely remain stuck in a range of 2.0% to 2.5% as it has for the last four years. Despite optimism every December that the New Year would bring some type of escape-velocity growth (3.0% to 4%), the actual level of economic growth has continued to disappoint investors, with sub-2.5% annual growth rates.
2014 was to have benefited from a huge swing in the government category as well as a continued big rebound in housing and a strengthening world economy. That didn't happen. Housing slowed because of affordability and credit tightness. Government did get a little better, but not nearly as much as hoped, as last year's budget agreement weighed on spending. In fact, as fiscal 2014 draws to a close, federal government spending looks to be lucky to grow at 1%, before adjusting for inflation. Voter pressure, pensions, and limited growth in the housing market have kept far more pressure than anticipated on state and local governments as well.
Furthermore, world growth has been a big disappointment. After just one year of mediocre growth, Europe didn't show any growth at all in the second quarter. China, too, has been a disappointment with both exports and real estate turning in poor results. China's currency has been weaker, also, which has helped exports to the U.S. and hurt imports. The bright side to this surprising world weakness has been more liberal central banks, falling inflation rates, and lower interest rates.
A continuing capacity gap (a very fancy way of measuring capacity utilization that includes labor) that is close to 5% as well as a lack of confidence have also kept a lid on business spending. Business spending is not a large part of the U.S. economy but has been unusually weak for most of this recovery.
Meanwhile the consumer continues to do relatively well, except for some weather-related weakness this winter. Still, consumer incomes have outpaced spending for most of 2014. Those higher incomes along with already-accumulated savings could fuel more consumer spending in 2015. The savings rate has increased from 4.4% to 5.5% on a three-month averaged basis. Weather-related issues, sky-high utility bills, a major food price shock, relatively high gasoline prices, and income inequality (more money in the hands of big savers) have all held back spending despite improved incomes.
I believe falling commodity prices, recent drops in gasoline prices, moderating utility bills, and the reduction in some food prices may provide the ammunition for more consumer spending in the back half of 2014.
A New Normal? Maybe. No Growth at All? Not Likely.
I have been worried for some time about the long-term growth potential of the world economy in general and the U.S. in particular. In the case of the U.S., I am most concerned about demographics limiting long-term growth. Population growth has been slowing since at least the 1960s. With it, GDP growth has slowed as well.
While the slow growth that the U.S has experienced is partially due to two financial market and stock market collapses in less than a decade, falling population growth rates might have already doomed U.S. growth rates to sub-par levels. The 2.0-2.5% growth that we are currently seeing compares to a 3.1% average GDP growth rate that we have seen over the last 60 years. Frankly, the high end (2.5%) of our growth rate forecast may not be attainable due to the aging U.S. population compounding the population growth figures.
As people age, it is well documented that they spend less; consumer spending typically peaks at age 50. With the trailing edge of the baby boomer generation passing the age 50 mark in 2014, it is not surprising that economic growth has been anemic. Indeed, the number of U.S.-born citizens turning 50 has declined by 273,000 people in 2014 compared with the peak baby boomer age 50 birthday year of 2007. The picture grows worse over the next nine years, with almost 900,000 fewer people turning 50 in 2023 versus 2014.
Demographics Are Not Just a U.S. Problem
Unfortunately, the demographic issue is afflicting more than the U.S. Japan went through the process first, and it hasn't been a pretty picture, with deflation and limited economic growth over a decade or more. Poor government and central bank policies as well as tight immigration limits aren't helping matters there, either.
Next up was Europe, which has clearly experienced a more severe birth drought than the U.S. Its growth rates have also trended sharply lower than in the U.S. Again, policy decisions haven't been optimal, but they have proved better than Japan, at least so far. Even China will likely see some slowing as the one-child policy of the post 1970s era takes control of China's demographic destiny.
While several authors in this quarterly report note softening Chinese demand, especially for commodities, shifting demographics will compound economic slowness due to China's move toward becoming a more consumer-driven economy. Although the arguments today seem to be whether China will grow at 7% instead of 7.5% in the very short run, the real issue is that China could be growing at less than 5% at some point over the next five years.
Housing, Exports, Low Rates Could All Help Save the Day
Lately, there was some fear that in the long term, U.S. GDP growth could slip well under 2%. That is as overblown as the expected return to 3%-plus growth was just a few short years ago. First and foremost, residential spending has yet to return to its normal level (5% of GDP), despite population growth and five years of economic recovery. Exports to the rest of the world will also help keep the U.S. growth story afloat. Airliners are likely to be in strong demand throughout the world over the next 10 years. With long production and design cycles, competition for the U.S. airliners will prove minimal. Growing agricultural demand and growing oil-related exports will also keep the U.S. ahead of the developed world growth rates.
Furthermore, despite a lot of teeth-gnashing and some slippage, the U.S. stacks up reasonably well on measures of world competitiveness. The World Economic Forum (of the famed Davos conference) ranked the U.S. third among 144 countries on 12 measures of competitiveness. That was better than last year's fifth-place ranking. I have often stated that the consumer drives U.S. economic activity. That is true in the short run. More correctly, though, competitiveness (which is affected by investments, red tape, access to capital, education, etc.) will continue to drive longer-term trends. A recent survey by Harvard Business School also suggests that the U.S. position has improved rather dramatically since the end of the recession.
Although interest rates are likely to be higher a year from now, I suspect long-term interest rates, both inflation-adjusted and nominal, will remain below long-term averages. The slower economic growth rates discussed above will be the primary reason for subdued rates. There are supply and demand issues at work, too. The fastest-growing businesses today often generate cash instead of use cash. That is in contrast to when General Motors (GM) and U.S. Steel (X) were engines of growth, demanding huge capital investments and massive borrowing.
In addition, mortgage debt still continues to decline five years into the economic recovery, as tighter lending rules, smaller home ownership rates, and more all-cash investor purchases drive down the need for housing finance. Less inflation and smaller growth rates also mean substantially less demand for working capital loans by businesses. On the supply side, aging baby boomers can't afford to be as aggressively invested in the volatile stock market as they retire. This in turn should mean more demand for bonds and help keep a lid on interest rates.
Those Consumers With Jobs Should See Wage Increases
As baby boomers continue to retire in droves, the working age population will begin to shrink beginning in 2015. At the same time, retirees will demand more labor-intensive health services, raising at least some demand for labor. This should in theory create some labor shortages and begin to lift wages and improve overall spending levels, at least of those still working.
We continue to hear stories of labor shortages (pilots, truck drivers, skilled machinists, and dry wallers) and believe these shortages will spread, though probably not touching the under-educated/under-trained sector of the population. With job openings well outpacing actual hiring, there is at least a temporary mismatch of skills and labor rates that will need to adjust over the next five years. The U.S. economy has proved adept at making those types of adjustments (for example, construction workers to medical workers over the last decade), but it won't happen overnight.
The mismatch of openings and candidates may also necessitate employers raising their wage expectations, which has clearly not happened yet. The impact of these higher wages isn't going to be uniform. Businesses with a low labor content but which sell to the working-age population could do very well. Meanwhile those with a high labor content, poor training and retention programs, and a focus on commodities could suffer.
Cross Sector Themes, Including a Softer China, Falling Commodity Prices, and Mergers and Acquisitions
In general, long-term growth in emerging markets continues to drive growth opportunities for some companies, especially consumer-oriented categories. However, China's ongoing shift away from investment and real estate and toward consumption is beginning to hurt the more commodity-oriented segments of both the Chinese and the world economies.
From metals to recycled paper and cement, Chinese demand is continuing to slow. In turn, that is pushing down prices and hurting producers across the basic materials sectors. However, I don't see many mentions at all of businesses benefiting from lower input prices just yet.
Many of Morningstar's sector teams believe growth estimates for China remain too high. Dan Rohr of our basic materials team is particularly skeptical of Chinese growth estimates based on his belief that the real estate market there has been deflating for some time, but time-lagged statistics have yet to fully catch up with a real estate market that has already slowed.
Some of our quarter-end sector reports also mention high merger-and-acquisition activity. Some mergers were clearly meant to improve competitive position, while others seemed more tax oriented. With the stock market and valuations now higher, and the government threatening to clamp down on tax-driven deals, I suspect M&A activity may end up being a smaller factor in expanding stock valuations in the quarters ahead.
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Robert Johnson, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.