Innovation Pushes Boundaries
US production has grown steadily for three consecutive quarters. The Bureau of Economic Analysis (BEA) estimates that first-quarter GDP grew at a 1.3% annualized rate. So the bright side of the story is that no official recession has started yet. But a darker picture reveals a GDP growth rate that trends well below the inflation rate or, more importantly, the forecasted inflation rate for the next several years. Of course, it can be common for growth rates to dip below inflation rates at various times. However, it does have the potential to become destabilizing if something doesn't come along to change it.
The word stagflation can enter the mind in periods used to describe low growth and elevated inflation. In addition, periods of stagflation are often associated with periods of market dislocations. Investors may even be able to identify a few market dislocations quite easily today, brought on by a tighter interest rate cycle and inflation. The ongoing nature of the inverted yield curve may serve as one of those examples where short-term interest rates earn more than long-term interest rates. A negatively sloped curve works against rational theory in which savers receive a savings premium for time.
Another source of friction exists in the business sector of the economy. Even though many publicly traded companies have successfully engineered earning-per-share results that have beaten predictions made by Wall Street, a much broader scope of the private sector reveals a picture where costs are high, and sales volumes are down. As a result, US businesses have reported two consecutive quarters of declining profits, according to new data from the BEA. So, despite the success of some good earners covered by Wall Street, the rest of the private sector has watched profit margins narrow.
Depressed private sector productivity is likely one factor contributing to today’s smaller growth rates. The US Bureau of Labor Statistics observed that worker productivity fell sharply in the first quarter. Higher labor costs are the possible cause as labor markets are currently extremely competitive. The latest jobs report showed that almost two jobs still exist for every unemployed person. In addition, wages continue to show gains above 4% per year. In response, some employers have resorted to stocking employees because it's difficult to find labor when needed. But, unfortunately, keeping unused employees on the payroll can eat into the bottom line and reduce growth rates.
Temporary declines in productivity are common as economic growth rates move through various cycles. But one new transition may be starting to emerge as artificial intelligence (AI) has entered the scene. AI may be the next technological breakthrough that boosts worker productivity and produces another leg up for private sector profits. Recent news of an unexpected surge in (graphic processing unit (GPU) sales gave a good lift to public market valuations in stocks close to or on the edges of AI. Investors seem convinced that the digital and automated transformation of the economy will unlock incredible value.
In the meantime, as investors wait for new technologies to gain a foothold in the economy, public markets contend with higher inflation and lower growth. Therefore, the public sector has searched for ways to subsidize costs and accelerate the adoption of new technologies into the economy. Recent appropriations passed in the CHIPS Act and the Inflation Reduction Act are prime examples of public policy support in the economy. Thankfully, the federal government will raise the debt ceiling to pay for the spending it has apportioned funds to. Had the government failed to reach a deal on the debt ceiling, it could have reduced government spending that might nudge the economy towards recession.
The economy will always travel through cycles that impact growth rates and inflation. Occasionally, a major breakthrough happens that permanently changes the economy's growth trajectory. The US may be standing on that precipice of time. AI and cost-saving technologies may be that next breakthrough that ushers in a whole new era of productivity.
