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Market View

Our investment experts discuss why the decade-long stretch of U.S. economic growth could last longer than forecasters expect.

 

In Brief

  • The current growth phase is on course to beat the reigning champion of U.S. economic recoveries—the 1990s expansion, which lasted 120 months.
  • The mere fact that productivity is not decelerating, as it normally would so deep into a period of economic growth, offers the potential for growth to be sustained.
  • What's impressive to us is that U.S. inflation decelerated as the U.S. economy was growing at 3.2% in the first quarter of 2019—all while the rest of the world was slowing down.   

 

We recently gathered six Lord Abbett investment leaders for a wide-ranging discussion of the current market and economic environment and to elicit their views on key investment themes for the second half of 2019. (Register for our June 13 webinar on our Midyear Outlook page.)

In this first of a special three-part Market View, we focus on one critical segment of the discussion: the current U.S. economic expansion—soon to be one of the longest growth periods in U.S. history.

Our panel featured Lord Abbett Partners Thomas O’Halloran, Portfolio Manager for micro-, small-, and large-cap growth strategies; Giulio Martini, Director of Strategic Asset Allocation; Daniel Solender, Director of Tax-Free Fixed Income; Leah Traub, a currency expert and Portfolio Manager for Taxable Fixed Income; and Kewjin Yuoh, Portfolio Manager for Taxable Fixed Income. Joseph Graham, Investment Strategist, moderated the discussion.

One of the major topics for our panel was the extraordinary length and breadth of the current U.S. economic recovery, which began in June 2009 following the Great Recession, according to the National Bureau of Economic Research. At 118 months long (as of May, 2019), the current growth phase is on course to beat the reigning champion of U.S. economic recoveries—the 1990s expansion, which lasted 120 months.

On everyone’s mind was the prospect for the recovery’s continuation. How sustainable is an expansion that is already a decade long? Isn’t it just getting a bit old?

Well, “business expansions don’t die of old age,” according to Martini. “They are either murdered or they commit suicide. When they’re murdered, the Fed [U.S. Federal Reserve] is tightening monetary policy to combat the threat of inflation, and that forces the economy into a downturn to correct the excesses that led to inflation.”

“When business expansions commit suicide,” Martini continued, “it’s usually because a financial bubble has burst, and that spills over to the economy by reducing household and business spending, causing a recession.”

With neither a Fed-induced nor a bubble-led recession in view, according to our experts, panelists pondered the possibility that the current expansion may exceed investors’ expectations in terms of its sustainability.

Martini points to the late-in-the-cycle appearance of productivity growth, which he says “has been missing in action up to now,” as one indicator of the sustainability of this recovery. Labor productivity growth in the nonfarm business sector accelerated at an unexpectedly strong 3.6% in the first quarter of 2019. This took the year-over-year gain to 2.4%, by far the swiftest advance in the current expansion, according to Martini.

 

Chart 1.  A Rise in Nonfarm Labor Productivity Has Been Supporting U.S. Economic Growth
U.S. nonfarm business sector labor productivity, output per hour worked (as of April 30, 2019)

Source: Bloomberg.  For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. 

 

“Since the recovery began in 2009, we’ve had very weak productivity growth, and that's resulted in slow wage increases and, frankly, a lot of dissatisfaction as people just didn't really feel the benefits of the economic expansion,” Martini said. “Then a couple of years ago, we started to see wage increases accelerate.”

“Normally, wage increases could pose an inflationary threat,” Martini continued. “But it's not doing so, because simultaneously productivity is picking up. That means production costs aren't going up, even though wages are. And in many ways, that kind of acceleration in productivity creates the potential to have the best of all possible worlds, because it means that households can have an improving standard of living, we can continue to have low inflation, businesses can maintain profit margins to the benefit of shareholders, and all of that coming together is something that we saw for extended periods of time in the 1960s, in the 1980s, in the mid-1990s, but we haven't seen for a while.”

“And if in fact the economy is entering a period of higher productivity growth, it's a signal that we may continue to have low inflation and maintain this economic expansion for longer than investors might have been counting on,” Martini said.

What’s Different This Time?
Martini points out that it is unusual for this kind of productivity growth to occur so late in a business cycle. “Generally, the pattern is for productivity growth to be very strong in the early phases of an economic recovery, when you're coming out of recession, and then for it to slowdown in the latter phases of business expansion.”

“The mere fact that productivity is not decelerating, as it normally would so deep into a period of economic growth, offers the potential for growth to be sustained,” Martini says. “We saw this happen in the long expansion period in the 1990s, when [former U.S. Federal Reserve chairman] Alan Greenspan famously perceived that technological change was allowing an acceleration in productivity growth that hadn't shown up in the data yet, but that he thought would allow the Fed to maintain low interest rates for longer.”

“In terms of the performance of the U.S. economy, that late-cycle acceleration and productivity growth was one of the things that really led to the longest period of uninterrupted economic growth (the 1990s) that we've ever had in history, at least so far,” Martini says.

“And there’s another thing that is unusual for a late-cycle environment,” Martini said. “Typically, housing is weakening in the latter phases of a business expansion. But it’s starting to strengthen now, and it’s another factor that could sustain growth.”

 “There are a lot of good aspects about housing right now,” Yuoh said, “affordability being one of them. Inventories are back to pre-housing crisis levels. Housing start numbers and existing home sales are comparable to the levels of the mid- to late-'90s. I think if we're going to have a significant recovery in housing, lending standards will have to ease up somewhat-- but that's something that will happen slowly. I don't see housing as a threat right now to the economic expansion.”

O’Halloran agrees. “I don’t believe that housing is going to be a big catalyst for growth, but it’s not going to be a problem either.”

O’Halloran is “very bullish” on the U.S. stock market, which he believes will break out to new highs soon. “And one of the main reasons is what we’ve been talking about: our economy continues to expand and inflation is very much under control.” (We’ll feature more investment views from our panel in Part 2.)

Solender also has a favorable outlook for the U.S. economy. “Consumer confidence remains strong. People today are working and making money. This year, most consumers feel comfortable with the current interest-rate environment (they weren’t last year), and they don’t seem to expect any move from the Fed to be a large one, either way.”  

“While it’s true that the Tax Reform Act redefined wealth for many homeowners living in high-tax states, all of that has created demand for the tax-exemption that municipal bonds can provide,” says Solender.

Finally, with her global perspective on the currency markets, Traub observed: “The United States, with 3.2% in gross domestic product in the first quarter of 2019, is where the growth is, and that supports the U.S. dollar,” Traub continues. “It’s hard to see where we will see dollar weakness unless global growth picks up. In that regard, Europe is struggling to exceed 1% and the Asian emerging markets are feeling the effect of the slowdown in China.”

“In hindsight,” Martini concluded, “the last year has been even more surprising than I thought it would be. China’s economy slowed, Europe’s economy slowed, yet U.S. GDP growth year-over-year in the first quarter turned out to be 3.2%.”

“Most people think that potential output growth, a long-run kind of noninflationary trend, is something like 1.8%” Martini said. “So the U.S. did almost double its potential output in a year when the rest of the world was slowing down. That's pretty impressive. What's more impressive to me is that inflation decelerated as the economy was growing at 3.2%.”

“What that really suggests, to me at least, is that those estimates of potential output are probably too low, that the economy's real potential in the medium term is growing more rapidly than we thought it was. And that's exactly what accelerating productivity would suggest.”

Next: Lord Abbett investment professionals assess prospects for key asset classes in the second half of 2019.

 

A Note about Risk: The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk. Credit risk is the risk that debt issuers will become unable to make timely interest payments, and at worst will fail to repay the principal amount. The municipal market can be affected by adverse tax, legislative, or political changes, and by the financial condition of the issuers of municipal securities. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state and local taxes may apply. Investments in Puerto Rico and other U.S. territories, commonwealths, and possessions may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems. Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes. Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. All investments involve risks, including the loss of principal invested.

This material is provided for general and educational purposes only. The examples provided are for illustrative purposes only, and are not indicative of any particular investor situation.

This Market View may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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