Declining population, productivity, and growth hurt stocks and bonds

Marc Wiersum, MBA

Is Baby Boomer retirement more good news for stocks and labor markets? (Part 7 of 13)

(Continued from Part 6)

Declining population, productivity, and GDP growth

The below graph reflects the ongoing decline in the U.S. population growth rate and productivity growth rate as well as their impact on overall economic growth rates—real GDP growth. We can see that the entry of the Baby Boomer generation into the labor market likely played a key role in sustaining productivity growth rates—the blue line. However, it now appears that the USA is entering an era of population growth of below 1.0% and productivity growth of around 1.0%. These factors suggest that the USA will face challenges in sustaining historical real growth rates of 2.5% per year or greater. As a result, the federal government may continue to run deficits in an effort to sustain economic growth in the future, though with net debt–to–GDP of around 80%, growing the deficit even further remains a controversial political and economic issue. This article considers the implications of declining productivity and population growth rates for equity investors.

To gain a broader understanding of the other macroeconomic factors supporting the economic and investment-related views in this series, please see Must-know 2014 US macro outlook: The crack in the debt ceiling.

Productivity growth offsets population declines

As economies mature into service-oriented economies and away from manufacturing, like the USA, it’s typically the case that capital and investments has been directed to more productive and profitable uses. This is generally achieved by investing in productivity-boosting technology, such as the computer, smartphone, and associated efficiency-enhancing software. While the digital revolution has made a significant contribution to the productivity of the U.S. economy, as the above graph reflects, the growth rate of productivity, relative to historical rates of growth, continues to decline.

More investment is required

As we pointed out in a prior article, Why is Obama angry with capitalists over private investment?, the level of investment in the U.S. economy has remained quite weak since the Dot Com bubble ended in 2001. Yet, thanks to low interest rates via the Fed, U.S. corporations have been able to post record profits. You’d wonder how long this could go on. Corporate equity buybacks and strong profitability have been quite positive for equity process since the 2008 crisis. However, without growth in reinvestment, the exodus of the Baby Boomers from the labor market will leave a smaller workforce to replace them in a low-productivity-growth environment—fewer bodies with lower growth in output per hour than previous generations.

Liquidity-driven markets aren’t sustainable

That is the recipe for economic stagnation. Eventually, higher tax rates and other forms of government involvement will likely have an impact on taxing corporate profits. That is the big risk factor for a liquidity-driven, rather than fundamental growth–driven, bull market in stocks. At some point, investment needs to develop in the USA and productivity growth rates need to improve to sustain consumption—nearly 70% of the U.S. GDP. As we noted in Part 3 of this series, the hope is that the U.S. political system, through new policy directives, specifically address and cure the “demand-side” weakness in the U.S. economy. Should the U.S. be able to innovate its way through the current weak economic environment through effective demand-side policies, we could see a dramatic reduction in unemployment and underemployment, a significant gain in economic growth, and perhaps an economic environment that’s more conducive to attracting investment capital.

Structural unemployment and TIJ (“This is Japan”)

When economists, traders, or politicians inquired as to why the Japanese government engaged in this ineffective policy, or that wasteful government spending initiative, in order to support their economy post-1990, the response was typically, “Because… This is Japan.” After a decade of high use, this turned into the widely used acronym “TIJ,” which essentially provided an political or economic explanation for everything—much like “structural unemployment” has in the USA since 2009. Those who had the opportunity to observe Japan’s “lost decade” (and beyond) first-hand (such as this writer) had become accustomed to giving up on clear thinking and simply accept this fatalistic interpretation of Japan’s political and economic reality or policy. It would seem that the U.S. has developed a similar response repertoire in response to apparent (according to economist Paul Krugman) economic policy shortcomings.


Should population and productivity growth rates continue to fade and Washington continue to proffer up “structural unemployment” as an excuse for better policy, equity investors should be concerned. Failure to make progress on the fundamental investment and growth conditions in the USA will lead to negative consequences in terms of higher taxes—and most likely for the wealthy. As a result, if you’re a Baby Boomer contemplating retiring on your equity investments in your 401K in ten years, you might want to curb your enthusiasm. Either the basic vital signs of the U.S. need to begin to improve, or there’s a good chance that taxes will go higher while real wages and purchasing power declines.

To see the overview of all labor sectors in the U.S. economy, from the short-term unemployed to the long-term unemployed, and all employment statuses in between (U-1 through U-6 Labor Data), please see the next article in this series.

To see how the “discouraged worker” impacts U.S. financial markets compared to the Baby Boomers generation dynamics, please see Is the discouraged worker a lagging indicator for the S&P 500?

T-Mobile USA: Good yield, reasonable cash flow–to–debt for a BB-

T-Mobile USA (TMUS) has a market capitalization of $25.44 billion and is also a BB credit. T-Mobile USA holds $22.68 billion in debt and $7.34 billion in cash, leaving about $18 billion in debt. In contrast to Verizon’s (VZ) 9.54% profit margin and Sprint’s (S) -8.5% profit margin, TMUS has a profit margin of 0.14%. TMUS has an earnings before interest and taxes (EBITDA) of $4.78 billion to service its $18 billion of net debt, while Sprint has $5.47 billion of EBITDA to service net debt of $25.5 billion, and Verizon has $48.57 of EBITDA to service its net debt of $42 billion. T-Mobile currently has a September 1, 2018, company-guaranteed bond yielding 3.00% versus CIT Group’s February 19, 2019, senior unsecured bond yielding 3.46%, Sprint’s August 15, 2007, senior unsecured bond yielding 2.95%, Verizon’s February 15, 2008, senior unsecured bond yielding 2.00%, and Caesar’s Entertainment’s June 1, 2017, senior secured bond yielding around 11.00% (Bloomberg & Capital IQ, December 31, 2013 Quarter).

Equity outlook: Cautious

Should the debt ceiling debate re-emerge after the mid-term elections in November, and macroeconomic data fail to rebound in sync with record corporate profits, investors may wish to consider limiting excessive exposure to the U.S. domestic economy, as reflected more completely in the iShares Russell 2000 Index (IWM). Alternatively, investors may wish to consider shifting equity exposure to more defensive consumer staples-related shares, as reflected in the iShares Russell 1000 Value Index (IWD).

Plus, even the global blue chip shares in the S&P 500 (SPY) or Dow Jones (DIA) could come under pressure in a rising interest rate environment accompanied by slowing consumption, investment, and economic growth. So investors may exercise greater caution when investing in the State Street Global Advisors S&P 500 SPDR (SPY) or the State Street Global Advisors Dow Jones SPDR (DIA) ETFs. Until there’s greater progress on the budget and federal debt issue, and consumption, investment, and GDP start to show greater signs of self-sustained growth, investors may wish to exercise caution and consider value and defensive sectors for investment, or individual companies such as Wal-Mart Stores (WMT).

Without sustained improvement in economic growth data, there’s little doubt that the debt level issue and tax reform will be a big issue later in the year. Current economic data noted in this series suggests that the probability of the 2013 sequester issue returning—in one form or another—could be higher than many think. The data is simply not that robust—yet.

Equity outlook: Constructive

However, if investors are confident in the ability of the USA to sustain the current economic recovery as a result of the improving macroeconomic data noted in this series, they may be willing to take a longer-term view and invest in U.S. equities at their current prices. With the S&P 500 (SPY) price-to-earnings ratio standing at 19.65 versus the historical average of around 15.50, the S&P is slightly rich in price—though earnings have been solid. However, with so much wealth sitting in risk-free and short-term financial assets, it’s possible to imagine that a large reallocation of capital that is “on strike,” including corporate profits, into long-term fixed investments. This could lead to greater economic growth rates and support both higher equity and housing prices as well. In the case of a constructive outlook, investors should consider investing in growth through the iShares Russell 1000 Growth Index (IWF) or through individual growth-oriented companies such as Google (GOOG).

Continue to Part 8

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