Outlining the U.S. Economys Growth Dichotomy
American Century Investments
October 27, 2011
G. David MacEwen, Chief Investment Officer of Fixed Income at American Century Investments,Â®Â describes â€śthe growth dichotomyâ€ť that has developed during the recovery from the Great Recession, and how itâ€™s restricted the recovery, softened consumer sentiment, influenced the fixed income teamâ€™s macroeconomic outlook, and shaped some of the teamâ€™s sector outlooks.
Dichotomy:Â Â A division or contrast between two things that are or are represented as being opposed or entirely different; a division or the process of dividing into two mutually exclusive or contradictory groups.
One of the key characteristics of the subpar, slow-growth recovery we have experienced since the Great Recession of 2007-09 has been the clear divide between the recovery rates of the business and consumer sectors.Â Basically, businesses (especially bigger, multinational firms) have bounced back faster and stronger than the average U.S. consumer who buys their goods and services.
Six Key Causes
Here are six key causes for what weâ€™ve taken to calling â€śthe growth dichotomyâ€ť between businesses and consumers, which has affected the U.S. economy and the financial markets, and put pressures on government for reforms:
- Corporate cost-cutting.Â Businesses responded to the recession by aggressively cutting costs, especially their labor costs. In other words, heavy layoffs and reduced benefits. This was an effective balance sheet-stabilizing strategy for businesses, but it extracted a significant toll from consumers.
- Productivity gains.Â Layoff strategies worked for corporate America because companies were able to retool and reallocate resources to reduce production losses despite having fewer labor resources.Â The remaining workforce became, in many cases, more efficient and productive, through various combinations of technology gains and improved management.
- Global economic expansion.Â Businesses, especially multinationals, benefited from global economic expansion, particularly in emerging markets such as China.Â Businesses found new, expanding markets for their goods and services, and also found plentiful, less costly labor resources in those countries.
- High U.S. unemployment.Â Â The combination of slow economic growth, layoffs (by both businesses and government), productivity gains, and available overseas labor has left the U.S. with a stubbornly high unemployment rate that weighs on consumer confidence and spending.
- Depressed U.S. housing market. Similarly, the substantial loss of home equity value in the U.S. since 2006 has significantly dampened consumer confidence and spending, with little relief in sight.
- Consumer debt conditions vs. business debt. While businesses have frequently benefited (in terms of further cutting their costs) from historically low interest rates, many consumers have had their access to further debt or refinance sources cut or severely restricted.
Illustrating the Issue
Sometimes pictures are worth a thousand words. In recent client presentations, weâ€™ve used the following chart to graphically illustrate our growth dichotomy discussion.
It shows a side-by-side comparison of some current constraints on U.S. consumers (declining home values, employment, and personal consumption) versus bolsters for business (rising earnings and increasing productivity). Itâ€™s not a comprehensive picture, but it makes the point:
The growth dichotomy isnâ€™t just fodder for presentations, or simply an economic and financial factor thatâ€™s facing investment managers and investors. We believe it also has broader reform implicationsâ€”the sustained economic pressures on consumers are now resulting in increasing pressures on corporations and governments to respond and enact reforms and legislation to ease current conditions and prevent this from happening again.
We donâ€™t think this is an issue thatâ€™s going away any time soon; we expect economic pressures on consumers to continue, and, therefore sustain outcries for reform. In this slow growth environment, we believe it could take an extended period for the U.S. housing and labor markets to improve significantly.
Meanwhile, governments, at the national, state, and local levels, are still going through the cost-cutting processes that corporations have mostly taken already, meaning that there could be more government spending cuts and layoffs for the economy and labor market to absorb.
Possible Pressures on Business Performance
Besides the potential reform and legislative implications, we think businesses should pay attention to the growth dichotomy for another reasonâ€”if consumer health lags business health by too much or for too long, the lack of consumer demand should, theoretically at least, affect business performance.Â In other words, businesses canâ€™t continue to succeed if they donâ€™t have financially viable customers willing and able to spend money on corporate goods and services.
To a certain extent, U.S. businesses have been buffered from this problem by expanding overseas demand. But even that canâ€™t continue forever, especially if thereâ€™s a continued global economic slowdown, potentially triggered by the European sovereign debt crisis and recessionary conditions in Europe.
Support for our Slow, Subpar Growth Outlook
The growth dichotomy and the questions and concerns surrounding it help support our most likely expected economic scenarioâ€”â€śsubpar recovery with headwindsâ€ťâ€”that we outlined in our teamâ€™s last update (â€śOur Fixed Income Macro Outlookâ€”Fourth Quarter 2011,â€ťÂ Weekly Market Update, October 11, 2011).
We donâ€™t think the U.S. economy will double-dip back into recession, but we do see a long, slow slog until consumer conditions improve.
Opportunities in Fixed Income
Meanwhile, where are we looking for opportunities? As always, we advocate a diversified, risk-managed approach that aims to provide expected bond-like performance from our bond portfolios.
Within that actively managed framework, we see opportunities in the corporate bond market.Â Corporate spreads (the yield difference between corporate and Treasury securities of the same maturity) widened during the risk reduction-related selloffs of the last two quarters, making corporates more attractive from both a yield and potential appreciation perspective, especially compared with Treasuries.
And we still like the fundamentals of corporates.Â Parts of the corporate market (especially in the high-yield sector) were being priced as though for recession at the end of the third quarter, yet default rates are still relatively low, corporate balance sheets are relatively strong, and we donâ€™t believe that a recession is the most likely outcome from this yearâ€™s economic slowdown.
For more information on our bond sector outlooks, where weâ€™re pursuing opportunities, and suggested fixed income allocations, please see our recent postings and stay tuned to this space for further updates, outlooks, and insights.
American Century InvestmentsÂ®Â offers a wide variety of stock, bond and asset allocation funds. Visit americancentury.com for more information:Â Â U.S Investment Professionals
The opinions expressed are those of G. David MacEwen and the fixed income portfolio management team at American Century Investments, and are no guarantee of the future performance of any American Century Investments portfolio. This information is not intended to serve as investment advice; it is for educational purposes only.
Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.
Diversification does not assure a profit, nor does it protect against loss of principal.
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