Hey, where’s the growth?

Why is economic growth slowing?

Mike Kelly
August 8, 2016 | 5 minute read

Investor goals are timeless. Whether planning for a retirement, saving for a vacation home, or putting children through college, investors have a variety of goals. And they place a deep level of trust in their financial advisor to help them achieve those goals. This sounds pretty straightforward. What is less straightforward is identifying investments to help achieve those goals.

For every investor, there are three main goals many portfolios seek to achieve: income, growth and diversification. It is crucial to look at each of these goals and discuss the investing headwinds we face today in achieving them. In this and future articles, we will discuss how to prepare portfolios to meet these challenges.

Let’s talk about growth.

Growth is a cornerstone goal for every portfolio. Portfolios need growth to thrive, like plants need water. But the weather has been changing lately and it feels like an arid spring in the markets these days. Why has growth been so difficult to achieve? Well, first, the U.S. economy is experiencing low growth and, even more importantly, it is slowing down. And this isn’t just a short-term financial headline. Economic growth, in fact, has been slowing down since the mid-1960s. That is a 50-year growth deceleration.

U.S. real GDP growth

Why is economic growth slowing?

There are two primary ways that an economy grows: an increase in the working-age population (i.e., more labor) and an increase in the productivity of those workers. In other words, to grow, an economy has to produce more, thus the term “gross domestic product” (or GDP).

So, how are those two measures doing? Well, growth in the U.S. working-age population is declining. We are getting older as a nation. Despite the fact that most Americans still retire at or around the age of 65, we are living much longer lives. And every day, approximately 10,000 baby boomers enter retirement.¹ Over the next 50 years, the working-age population growth rate is forecast to be a stagnant 0.25%.² Also, we are having fewer babies as a nation. Birth rates in the U.S. have declined sharply over the decades.³ So, overall, we have fewer workers and young people entering the workforce to support the ever-growing retired and non-worker population. We are undergoing the biggest demographic transition in modern history. And that demographic dynamic is fundamentally slowing economic growth.

Second, productivity growth has slowed considerably, especially in recent years. In 2015, labor productivity grew just 0.6%. Productivity can be volatile quarter to quarter, but looked at as a 5-year moving average, productivity growth, now just above zero, has fallen to its lowest level in more than 30 years.⁴ Why is this? There are entire books dedicated to this “productivity paradox,” and economist Robert Solow famously said, “You can see the computer age everywhere but in the productivity statistics.” The rationale that resonates the most, for me, is that we are just not investing in our companies and workforce in the U.S. as we have in the past. Private business investment has been unusually low of late relative to history. As a result of the Fed’s dovish monetary policies, it has been cheaper for companies to borrow and use cash and debt to buy back stock versus re-investing in people, plants and equipment. Stock buybacks have equated to $600 billion in the past 12 months alone.⁵ While this form of financial engineering may increase earnings per share in the short run, it does nothing for long-term corporate and economic growth.

These two long-term trends are acting as speed bumps to growth, and they don’t appear set to change any time soon. As a result, growth will likely be low and slow for the foreseeable future.

We’re stuck in a global growth rut. Oh, and it’s a global, not national, phenomenon.

Japan and Europe. Both regions have a head start on the U.S. and have been experiencing a dramatic aging of their populations and a decline in the size of the work force.⁶ These are bad signs for future growth in these two massive economies. Plus both of their central banks have taken on massive amounts of debt to overcome their slowing growth – which we know also slows growth.

China. There was a lot of talk five to ten years ago about how the Great Dragon will save our economic hides; but they’re now facing a similar challenge. Today, China is an emerging market with a developed market problem. The working age population declined by 5 million workers last year alone, signifying a decrease in the labor force and portending slower future growth in their economy.⁶ Their one-child mandate of 1979 appears to have stunted their growth. As China’s workers are now retiring, they are also now short on young people to replace the aging population.

So why the economic lesson?

Twenty percent of the U.S. population will be at retirement age or in retirement in the next decade.⁷ Retirees are living well into their 80s, 90s, or even 100s, rather than retiring at 65 and living until 72.

And that is great news for all of us. But here’s the real financial implication we all need to grapple with: even though retirement is now a 20- or 30-year phenomenon, the size of the proverbial nest egg isn’t keeping pace with the rise in life expectancy.

That’s why this economic lesson matters. Investors are going to need growth just when there is less of it around the world.

What should investors do?

Investing today requires a new approach to portfolio construction.

The current market environment calls for investing across a wider range of investments and portfolio constructions that provide for greater diversification and lower correlation to traditional stocks and bonds. More than ever, individuals need financial advisors to help develop tailor-made solutions that address today’s investment challenges.

This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.

Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.

All investing is subject to risk, including the possible loss of the money you invest.

Mike Kelly

Co-President + Chief Investment Officer

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