With solid economic growth data presented in December, the consensus is that the economy probably grew at a 3% clip or higher during Q4 2017. If true, that would be three straight quarters of 3% or higher growth for the first time since the financial crisis. (In 2013-14, we hit those numbers or higher in four out of five quarters.) The stock market was a huge beneficiary in 2017, and it may continue to be.
Why economic growth is so strong
It is important to point out that this momentum was several years in the making. Under President Obama, restrictive policies and extreme weather events kept the economy growing at a slower (though solid) pace. President Trump has removed some regulations but otherwise has not disturbed the economy.
You might hear some experts say that the economic growth in 2017 is a mirage or a one-off. I’m not so sure about that. I believe this level could be sustained for three reasons: stronger productivity, a strong labor market and tame inflation. This combination ensures the Fed stays out of the way. If inflationary winds pick up, the Fed will step in and aggressively raise rates. That could put the economy into a recession (it usually does), but we are far away from that point right now.
Keep in mind that productivity moves slowly
Because the US has such a large economy, productivity moves very slowly. It’ll take several quarters before we see meaningful moves. Looking at the chart from the Richmond Fed, you can see an uptick in productivity levels. They are not huge, but they are certainly trending in the right direction. We have along way to go before we reach levels from 2004-05, but this is a start. Higher productivity means companies can produce more goods and services at a more efficient rate and not be forced to raise prices to pay for wage gains, taxes and other expenses.
Productive workers will take home better pay (in theory, but it’s not happening now) while the consumer benefits. Our products are more competitive overseas, too. The key here is not allowing inflation to take hold and push prices higher.
Looking again at the chart, the US enjoyed very strong economic growth, higher productivity and declining inflation during the 1960’s and 1980’s. It’s no surprise that this positive combination drove a long up-cycle for the stock market during these timeframes. While there are boom and bust cycles, we are perhaps in the early stages of a strong productivity cycle. If we are, this may lead to a strong stock market for a few more years.
Copyright: pogonici / 123RF Stock Photo