Labor Day is here. For some, along with Memorial Day, it bookends the summer, and that’s that. It represents the end of the heat, and the beginning of another school year. In fact, the date became a national holiday in 1894 to recognize the incredible achievements of the American worker. This was around the time the AC motor, the radio, the gasoline engine and a plethora of other economic dial-movers were discovered. It was a period of dynamic technological change. Today, robotics, drones, AI and the like are transforming the world and how we work.
Labor (productivity) is important today as one of the two primary components of economic growth along with population growth. Population growth is on the decline, so the emphasis is on technological innovation to make the U.S. laborer more efficient. Curiously, the U.S.’s total output, measured by GDP, has been growing at a lackluster rate ever since the Great Recession. Payroll numbers have been growing steadily for years now and the unemployment rate is at a low 4.9%, but GDP growth has not been able to pick up.
Last year (2015) U.S. GDP measured 2.4% and stock returns, measured by the S&P 500, were 1.4%. This year, despite equally low-growth, stock prices have been rising. I suspect there are several things happening here. One is the market may be anticipating stronger growth and increasing estimates for Q4 2016 and 2017. With the election coming up, the market seems to be anticipating a change in the use of fiscal policy. It would appear that ideology aside, policy makers (not the Federal Reserve) realize they are the ones that can make a difference. Little if anything constructive has been done to spur economic growth since the American Recovery and Reinvestment Act of 2009 – far too long.
Another change the market may be anticipating has to do with how corporate America allocates its prodigious cash flow. Traditionally, spending by businesses large and small is oriented around research, innovation, capital investment and expansion. These are factors that have traditionally propelled the future growth of American industry. Recently, much of the surplus cash has been oriented toward pleasing investors on Wall Street in the form of higher dividends and stock buybacks. This may be good for the board room and bonus calculations, but it is not the correct route to sustainable growth.
Last, but not least, the most evident driver of the strong stock market this year (stocks have generated a total return of 7.66% year to date as measured by the S&P 500) is the search for yield. For multiple reasons, bond yields are as low as they have ever been. On top of this, demand for yield is off the charts, as our sovereign counterparts, Germany and Japan, are paying negative yields on their debt. This makes the current 2.1% yield on the S&P 500 look extremely attractive to income investors, and not just U.S. investors – there is evidence of huge demand for U.S. equities from Europe and Asia.
Stock sectors known for their dividends, such as utilities and telecom, are up 20% year to date. It’s no surprise that high dividend payers and value oriented stocks such as these continue to outpace growth stocks. The shift from growth to value, as I have discussed before, began in December 2015 and accelerated into 2016. I am making a somewhat contrarian bet that a positive inflection in earnings growth in the coming months will allow growth stocks to return to the head of the pack.
It’s hard to grasp the degree to which the world has changed since 1894. The role of labor and the importance of technology are as critical as ever, though they bear little resemblance to what they were. I have to say, the recent dust up between Apple, Ireland and the EU reflects just how critical innovation in the labor force has become. A recent Fortune list of the largest technology companies around the globe showed that of the top 25, 14 are from the U.S., 8 are from Asia-Pacific (China, Taiwan and South Korea) and only 3 are from the Euro-zone (Germany, Sweden and Finland). That says a lot.
Please feel free to check in if we have not spoken recently. The last few months have been smooth sailing, and often times that means there’s a storm somewhere on the horizon, even if we cannot see it yet.
Bruce Hotaling, CFA