Economic growth usually comes from consumer spending, business investment and net exports. In looking at past recoveries, other key historical lessons include the following:
- Household deleveraging lasts for 5 to 7 years. The U.S. has 3 years to go.
- Consumer spending growth does not remain at a depressed pace for the entire household deleveraging phase. Instead, spending growth gradually accelerates as the deleveraging matures.
- The business sector follows the household sector; capital spending accelerates with a lag as business leaders become more comfortable with the sustainability of the economic recovery.
- A boost from the trade sector certainly helps.
- Post-bubble recoveries can be sustained even in the face of both household and government deleveraging. Real GDP growth can even be well above-trend during fiscal consolidations.
- However, significant fiscal tightening should wait until there is sufficient momentum in the private sector, and the consolidation should be spread out rather than front-loaded (i.e., 1.5% per year or less). Under these conditions, the fiscal drag becomes a headwind to growth, rather than a force that derails the recovery.
One strike that the U.S. has against it in this recovery is that it cannot expect any sustained kick from an export boom. In past cycles, countries endured deleveraging at a time when growth in the rest of the world was healthy. This year, while global growth might show some acceleration, there will be no boom to drive U.S. exports.
Nonetheless, U.S. household deleveraging is approaching a stage where growth can finally shift to a sustained above-trend pace. Debt service burdens are the lowest in 20 years, and sharply reduced debt/income levels highlight that the deleveraging process is well advanced. Home prices are rising again and household net worth has almost returned to the pre-Lehman peak. Fading headwinds should allow household spending growth to gradually strengthen. Moreover:
- The business sector is in a good position to ramp up capex once the uncertainty over fiscal policy lifts. There is plenty of cash on balance sheets, interest rates are extremely low, and the demand for corporate bonds seems insatiable. Moreover, last year’s spending hiatus ahead of the fiscal cliff reinforced pent-up demand for capital spending.
- Agriculture could add 0.5% to real GDP growth alone, as long as a more normal weather pattern emerges this year.
- Residential investment could add 0.5 – 0.7% to real GDP growth.
- Shale energy development will add another couple of tenths to growth.
The bottom line is that 2013 should be a transition year from a below-trend growth environment to one that is more solidly above-trend, and thus one that investors and business leaders believe is more sustainable. This transition will have important implications for investor psychology, market correlation and risk premia. For one, price multiples will expand as the equity risk premium finally begins to mean-revert.
Expect February to be an interesting headline month as sequestration issues come front and center in Washington. Right now, we have a rally in need of a recovery. Global markets have rallied in anticipation of an economic recovery that is yet to materialize. To embrace it, you have to believe deleveraging – the main force suppressing global growth – will start to fade and that central banks will maintain easy monetary policy.
Michael Ashley Schulman, CFA