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Curb Your Economic Pessimism
The economy has been in a tepid, soft, slow recovery for the past five-and-a-half years. It’s the weakest rebound in generations. The Commerce Department’s revision of fourth-quarter GDP shows that nothing much has changed. Over the past year, real economic growth registered 2.4 percent, slightly higher than the recovery average. It ain’t much.
Meanwhile, winter economic reports for retail sales, manufacturing, and capital investment point to a weaker first quarter, perhaps around 1 percent. And Wall Street is talking about a possible profits recession, with expectations of a 2 or 3 percent drop in corporate earnings for the first half of 2015. So the market bears are out in full force.
Now, let’s acknowledge that coming off a deep recession, the rebound should have been 4 or 5 percent, not 2 percent. By some calculations, GDP is 10 percent — or nearly $2 trillion — below its long-term trend, and jobs may be lagging by 8 to 10 million.
Government entitlement transfers pay people not to work. Family breakdown has created a poverty trap for the lowest economic groups. Upward mobility is lagging. And the government has attacked the high-end movers and shakers with tax hikes and overregulation.
And unfortunately, a damaging business psychology prevails. It says that success must be punished, and that redistribution is the way to solve inadequate growth, inequality, and unhappiness.
But… all this said… it’s possible to be too pessimistic.
Let’s start with profits, the mother’s milk of stocks and lifeblood of the economy. The recent GDP report shows a slight profits decline in 2014, the first in years. But this is misleading.
More important, the core measure of earnings, domestic nonfinancial profits, increased 1.4 percent in the fourth quarter and 7.8 percent for 2014. On an annual basis these profits increased $262 billion and were widespread across industries.
The big problem is not the U.S., but the rest of the world, which is mostly in recession and saw profits drop $36 billion in the fourth quarter. At roughly 18 percent, profits from the rest of the world account for the smallest share of corporate earnings since 2006.
By the way, GDP profits from the National Income Accounts are far larger, and therefore more telling, than S&P 500 profits. Initial quarterly estimates from GDP cover about 9,000 companies. Over time, annual revisions will cover roughly 4 million companies. And GDP profits are benchmarked to IRS tax filings, with no accounting shenanigans.
Another economic positive is the rise of the consumer. Rex Nutting of MarketWatch reminds us that consumers got a big windfall from plunging energy prices. So far they’ve saved it, but that may change. Real incomes adjusted for taxes and inflation jumped at a 7.7 percent annual rate over the past three months. This could set the stage for a big boost in consumer spending.
The terrible winter has taken its toll in Q1. But family spending may jump come spring and summer. Along with this, the basic core of the private economy (consumption plus investment), which rose over 4 percent in the fourth quarter and 3.3 percent for 2014, will continue to advance.
Did somebody say King Dollar? It’s holding down consumer prices and business costs (including energy). Even with a lousy world economy, U.S. exports increased 4.5 percent annually in the fourth quarter while imports jumped 10.4 percent. So U.S. businesses are very competitive regarding export sales, and the rise in American imports from overseas will bolster the international economy.
One last encouraging point: C&I business loans have increased over 15 percent annually in the last three months and about 12.5 percent in the past year. That’s a good sign, especially for Main Street business activity, which has been lagging for years.
The Fed will probably raise its target rate later rather than sooner, smaller rather than larger. I’m betting on October and December for some quarter-point rate hikes. That’s consistent with a high dollar and low commodity prices. I doubt long-term rates will change much at all.
So moderate growth, rising core profits, and a still accommodative Fed set the stage for a better stock market as the year goes on. I’m still in the “buy the dip” camp. We’re not going to get the kind of growth that America is capable of producing until we get tax and regulatory relief and a better attitude about free-market capitalism. But I wouldn’t get too pessimistic.
There’s no recession or inflation in sight, and America is a very resilient place.
Don’t bet against it.
Published in Economics
Mr Kudlow,
It is an honor to have you post on this site; perhaps you will find the time to answer two questions:
1) Why is the market so unusually volatile? I do my homework on companies and only invest in the tech blue chips and interesting but cheap new stocks. Yet I find myself forever in a position of “3-4 day trading.” I’m not complaining; I enjoyed a 20% increase in my portfolio in 2014 but I never left my computer screen!
For instance, what the heck was the problem with Icahn? (Sold my shares at $136 last year – glad I did – but didn’t want to.)
2) What’s going on with Michael Burry? Would he ever consider taking on a double AA minor league player?
Thanks for your wisdom and any you may wish to impart to me.
Punish success with confiscatory taxation & regulation, vilify hard work, create and coddle imagined “victims”, subsidize idleness, spend more than produced for 40 years, reward debt, penalize savings, manufacture ever fewer tangible goods, open borders to unlimited unskilled individuals who do not wish to assimilate…
In as sense, he was right in saying, “You didn’t build that.” Plenty of would-be entrepreneurs have decided, “Why bother?”
Why not be optimistic. It has minimal marginal cost (like printing dollars) and big upside.
You might want to leave that one off the anathema list. Kudlow is an open-borders fanatic…
Then why doesn’t the Fed raise rates now to somewhere near their historical normal levels, rather than only later and only then a trivial amount? Because we all know that raising rates to 4 or 5 percent would make our debt unserviceable, prick the stock market bubble, and plunge us into depression. Which shows that the “recovery” is merely a function of the cheap money the Fed has been dispensing since 2009. And as soon as it cuts it off, the party is over.
Even with a lousy world economy, U.S. exports increased 4.5 percent annually in the fourth quarter while imports jumped 10.4 percent. So U.S. businesses are very competitive regarding export sales, and the rise in American imports from overseas will bolster the international economy.
Mr Kudlow: Are John Deere tractors made in China considered an Import or an Export? Are Apple phones, produced in China, an Import or an Export?
One reason that the economy seems to be doing poorly is that the media uses invalid metrics to measure what is happening. Most commonly used is median wages. The median wage is suppressed by the inclusion of millions of low-wage, low-income illegal immigrants in the economy. Median means the fiftieth percentile – the guy in the middle. Import millions of people at the low end, and you drag down the median.
Another invalid metric is wealth inequality. It is tacit in the “wealth inequality” narrative that the rich must be getting richer at the expense of the poor. The economy is a zero sum game (in the minds of lefties), so inequality means that the rich are stealing from the poor. Nice narrative, but utterly false. Wealth inequality is a sign of a successful investor/entrepreneur class. The poor do better in a society with greater wealth inequality. If you want to see what a society without wealth inequality looks like, visit Cuba. Really, check it out. Obama says it’s okay to go there.
I certainly don’t claim any special economic credentials comparable to anyone here but it seems to me that if we were first to acknowledge – given more than six years of TARP-Stimulus-QE(1-Infinity) as well as phony inflation and employment numbers – that the heavily pumped “tepid, soft, slow recovery” is really just a fiction, I see no reason not to add an “11” to my pessimism dial. We are in a deep hole and have continued to dig faster and faster for far too long. As Mr. Climacus indicates…at some point the party will end.
With all due respect, for many of us those experts who insisted on seeing “green shoots” back in 2009 were overly excited about what was really just a field of weeds. Instead of a taking the required medicine at the time, “we” chose a soft landing for us at the expense of generations to come.
So here we are supposed to be bucked-up by the promise of “a better stock market as the year goes on” based on the actions of those who led us into this hole. Well, I’m sorry, but I’m not buying it.
What a pleasure to come to one of my favorite sites & find one of the finest financial commentators and defenders of free markets here holding forth for our benefit. Thank you, Mr. Kudlow. Very good to have you.
I wonder if the increase of C&I loans will move money off bank balance sheets into the broader economy? Will it finally increase the multiplier of the monetary base to the money supply? Does that increase the risk of inflation? The multiplier averaged around 8x pre-recession, but has hovered around 3x since, largely because the enormous increase in the monetary base hasn’t been loaned out. Any thoughts?
Larry, before seeing your post on Ricochet I read it on this mornings RealClearMarkets.com.
It was listed right above “How The Fed Is Screwed” and “A Ferocious Market Washout”.
This is what keeps me up at night. Larry, please advise how to protect ourselves against Armageddon (my major concern). I’ve cashed out before but I’m even more concerned now about insuring my money … with whom?
Its hard to say the entire world has gone mad.
I would say, salt sugar and oil.
At a time when asset inflation has increased the gap between the wealthy and everyone else, it doesn’t seem right to blame the sluggish economy on redistributionist policies. It may be right that the wealthy are under more pressure from fiscal and regulatory policies, but they have been the prime beneficiaries of monetary policy. By far.
I’ll stop being pessimistic when Obama is out of office. Right now there is a gloom over the entire country, and it won’t go away with him there.