Eight years after the global financial crisis, could a change in policy priorities finally ignite an era of growth?
In 2013, Harvard University economist Larry Summers warned that the global economy was in danger of entering a period of “secular stagnation”—a concept created in the 1930s to describe a period of low or nonexistent growth due to a glut of savings and diminished investing.
In the past few years, investors have taken this theory to heart, believing that perpetually slow economic growth, low interest rates and subpar investment returns are inevitable. This skepticism about the future—even with asset prices rising—has created a negative feedback loop, driving investors to safe harbors such as cash, bonds, gold and yield-generating securities thereby reducing demand, inflation and growth in an ongoing vicious cycle.
However, Morgan Stanley Wealth Management has a considerably different outlook, one in which the U.S. economy is neither trapped by secular forces nor mired in stagnation. On the contrary, “the U.S. economy has shown remarkable resilience considering it has endured the perfect storm of economic headwinds which were amplified by anti-growth policy priorities," says Lisa Shalett, Head of Investment & Portfolio Strategies.
In a new report, “Beyond Secular Stagnation," Morgan Stanley’s Global Investment Committee deconstructs the consensus view by examining some of the most frequently-cited drivers of secular stagnation. The conclusion: the same headwinds that have impeded growth are now poised for an about-face. In fact, if combined with bold new policy leadership, we would be entering a new era of growth and investment opportunities.
A Supercycle Perfect Storm Amplified by Policy Headwinds
At first glance, Summers’ diagnosis may have been spot on. Average annual U.S. real GDP growth since 2009 has been just 2.2% versus 3.8% from 1940 through 2009. Negative real yields and valuations of long-term bonds imply virtually no growth and only minimal inflation for three decades.
The drivers of this low growth environment stem from four secular headwinds—aging demographics, depressed productivity, high global debt levels and incessant deflation deriving from globalization. These headwinds were then amplified by anti-growth policy choices such as excessive regulation, fiscal austerity, a lack of pro-growth private investment incentives combined with growing income inequality.
While the combination of secular headwinds and policy missteps help explain an unprecedented time of economic malaise, positioning for secular stagnation “may not be the right playbook for investors," says Asset Allocation Strategist Joe Pickhardt. “We conclude that the four major secular headwinds may actually be approaching their natural turns.”
Demographics is Destiny
Economic growth depends largely on the size of the population in the labor force, making the steady wave of baby boomer retirees cause for concern. During the current decade, labor-force participation plummeted to 63%, down from 66% in the previous decade.
What many investors have failed to realize, however, is that the U.S. economy has already endured the worst of this demographic shift, and the trend is poised to decelerate. Millennials not only outnumber boomers by as much as 6 million, they have just started entering peak working age. “Although the consensus acknowledges the arrival of the millennial generation (those born 1981-2000) into the workforce, few appreciate the sheer size of this wave, which is estimated at 83 million and doesn't really tail off even as we enter 'Generation Z,'" says Shalett. Consequently, working age population growth has begun to stabilize and is likely to see resurgence in 2025.
Millennials and Generation Z Will Soon Be a Tailwind for Growth
Productivity: Is the Worst Behind Us?
Productivity growth is another major contributor to economic expansion, and the last five years have come up short: productivity grew just 0.5% a year on average over the last five years versus 2.2% average gains for the past 70 years.
There are many theories behind the vexing slump in productivity. The cause isn't a lack of innovation, Morgan Stanley concludes, but a lack of broad-based adoption of productivity-enhancing technologies, namely to service industries and small businesses. As more businesses find ways to adopt new technology—from cloud computing to machine learning and 3D printing—productivity gains should recover.
Meanwhile, spending on research and development in the private sector has been increasing at a clip of 4.9% a year since 2007, up from 4.1% the decade prior, while public and private R&D as a share of GDP recently hit an all-time high. “The last time R&D's share of GDP was in this range was during the mid-1960s, when the country was in a 'Space Race' to beat Russia to the moon," says Laetsch. This should bode well for future innovation and productivity growth.
R&D Has Fared Better, A Positive Harbinger
Debt to GDP Ratios Have Increased…But Borrowing Has Slowed
Another drag on growth is public and privately held debt. Privately held debt of the U.S. government as a share of GDP increased this cycle to 74% from 39% in 2008, prompting concern that the U.S. is doomed to a debt trap in which high debt and low yields result in more debt. Even so the rate of debt accumulation—for government, corporations and households—has materially slowed, suggesting that the worst of deleveraging headwinds are behind us.
Meanwhile, debt relative to total assets—which is what matters most—is back to near pre-crisis levels. Interest rate payments on U.S. government debt are only 1.2% of GDP, near a 40-year low. U.S. households have also delevered debt, with the ratio of current obligations to income at 15.3%, the lowest since the early 1980s. And although corporations are increasing gross leverage, their cash-to-debt ratios (recently 13.7%) are still well above the 10% average from 1985 to 2007.
A Needed Shift in Man-Made Policy Decisions
At the same time, demographic shifts, debt accumulation and productivity plateaus have contributed to slow growth, policy-driven variables that have exacerbated the headwinds. Morgan Stanley estimates that more than two-thirds to three quarters of the $2.5 trillion output gap endured this decade can be traced to man-made policy missteps: fiscal austerity, growing income inequality, regulation and investment policy.
There is no easy fix for the man-made problems that have stymied growth, but again investors shouldn't assume that the status quo will continue. “We believe the political pendulums are swinging—whether from the left or the right, as candidates embrace more populist positions and associate a move away from austerity with other anti-establishment and anti-incumbent rhetoric,” says Shalett. What's needed: fiscal spending on infrastructure; comprehensive corporate and personal tax reform, less bureaucratic red tape, and entitlement reform and a roll back on excessive regulation.
There is no single solution to sidestep stagnation, but focused policy actions could have a significant multiplier effect. “When investors appreciate the extent to which the current recovery has endured the perfect 1,000-year storm, further aggravated by bad policy choices," says Pickhardt, “opportunities will appear.”
This article was adapted from the Morgan Stanley Wealth Management report “Beyond Secular Stagnation.” You can also watch a video presentation of the report’s analysis.
Rethinking Secular Stagnation
Joseph Pickhardt and Joe Laetsch are not members of the Global Investment Committee and any implementation strategies suggested have not been reviewed or approved by the Global Investment Committee.
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