Q: The U.S. economic expansion appears to be continuing at a moderate pace into 2014. Are you surprised?
A: Not at all. We switched from negative to positive on the economy back in the Spring of 2009 and have not wavered since then. The key to our confidence has been the message from our proprietary Recession Signals Checklist (the RSC).
Q: That doesn’t sound like the name of a “quantitative econometric model”!
A: That’s correct – however, each factor on the RSC does have a quantifiable level that causes it to toggle on/off. We tested dozens of economic data series and chose 10 that represent major economic sectors and interest rates. Our “back-test” period for the RSC covered 1980-2006, which included recessions in 1980, 1982, 1991 and 2001. In each of those instances, 9 or 10 of the RSC data series reached the quantified levels that signaled a high risk of recession. Equally importantly, we did not want “false positives” every time the economy slowed significantly, so we focused on the 1985 and 1995 mid-cycle slowdowns when many economists feared a recession was imminent. No more than 3 signals toggled on in those instances.
Q: How has it worked in real time since then?
A: To paraphrase the golf adage, “Back-tests are for show, but real-time is for dough!” Thus far, the RSC has been very helpful to us as it strongly signaled recession as the Great Recession developed in 2008. Per the title of this interview, many economists were surprised when the economy avoided falling into a double-dip recession in 2010, 2011 and again in 2012. The RSC held at 2 or 3 signals most of that stretch, but hit a rather nerve-wracking 4 of 10 in 2011. Overall, these low RSC readings gave us confidence in the economic expansion. While it’s nice to make accurate forecasts, the payoff was the support the forecast gave to our bullish investment strategies.
Q: What is the RSC telling you now?
A: Currently, NO signals are toggled on which supports our sanguine economic outlook for 2014.
Q: Are there additional factors that encourage optimism on the economy?
A: Absolutely. We see several factors that could lead to better growth, including: 1) reduced drag from Government spending cuts (state & local spending is already growing and the year/year impact of Federal sequester spending cuts has dropped), 2) an improving global economy helps export demand (Europe and Japan are coming out of recessions and emerging economies continue to outgrow developed), 3) low U.S. energy costs (fracking means North American natural gas costs are fractions of global levels), 4) consumers and businesses alike will benefit from improved balance sheets and renewed credit growth, 5) steady jobs growth (finally, a new high in jobs in 2014) will help consumer confidence and incomes, and 6) the U.S. “manufacturing renaissance” .
Q: That last factor sounds meaningful for our region –can you elaborate on it?
A: The era of “offshoring” of production seems to be reversing into re-shoring as the U.S. holds its position as the #1 or #2 country in the world in terms of manufacturing output. Shifting dynamics of global labor markets are playing a role in this, as is the advantage of lower domestic energy costs, but technology is a huge factor. Digitization and robotics have played a significant role in the massive productivity edge U.S. manufacturers hold over emerging market competitors. That advantage is a two-edged sword in terms of jobs in our region, as the automation-related jobs pay better. However, they require more education and technical training and are less numerous than the repetitive tasks of days gone by.
So to conclude, we have not been surprised by the growth of the U.S. economy and we remain optimistic that the pace of GDP growth is finally escaping the “terrible twos” and headed toward the more “pleasant threes!”
Disclosure: This message does not constitute individual investment, legal or tax advice. All opinions are reflective of judgments made on the original date of publication and do not constitute a guarantee of present or future financial market conditions.
