The Bipolar Express

It was not supposed to be like this. 2014 was supposed to be the year when the U.S. economy reached escape velocity, the Eurozone was expected to throw off the shackles of a sovereign debt crisis on the periphery, China was supposed to fulfill its destiny and South America was expected to rival its neighbors to the north. With the exception of the U.S. economy printing 4.6% GDP in the second quarter and probably on its way to a 3.0% plus print in Q3, 2014 has been somewhat disappointing. Still some of the U.S. economic data has been encouraging. The best way we can describe economic conditions is, bipolar. (5) The Bipolar Express Economic conditions have a manic feel about them. The Unemployment Rates is now down at 5.9%, but wage growth is only about 2.0% and 0.0% in real terms (vs. CPI of about 2.0%). Some industries complain of worker shortages, but with rare exceptions, wage growth remains lackluster. Even the kind of hiring we are seeing is Bipolar. Much of the hiring seen during the current expansion has occurred at the low and high end of the wage scale. Relatively little hiring has taken place in the middle-income semi-skilled area of the economy. Jobs in this sector have been largely replaced by technology. It seems that each and every year, economists predict that this will be the year that wage growth picks up. Thus far, economists have been disappointed. It might be that economic bipolarism is permanent, or at least semi-permanent. Technology and a global competition for labor are working to keep a lid on wage growth (but not necessarily wages). As we do not envision the pace of technological advancement slowing or the desire for employment to dissipate around the globe, conditions for modest wage growth could be with us for a long time. If the global economy is viewed as one entity, it demonstrates a split personality. On the cheerier side there is the U.S. economy. It is growing in spite of little help on the fiscal side, households which still have fairly high levels of debt and headwinds blowing in from overseas. What is the key to U.S. economic growth? The answer is: business flexibility. In the United States, business can more easily adjust staffing levels. They can reduce, add or move production to different locales. U.S. businesses tend to be more nimble and responsive to changing consumer tastes than many of their foreign counterparts. The Eurozone economy might be the polar opposite of the U.S. economy. Businesses cannot easily adjust staffing or shutdown plants without running afoul of government regulations. There is little dynamism in the Eurozone economy. As last week’s IMF report intimated, it is too easy to remain unemployed in the Eurozone. What incentives are there for small business creation if unemployment benefits are nearly endless and government regulations make starting a business difficult? Since the European sovereign debt crisis of 2012, it was hoped that Germany (the Eurozone’s largest and most flexible economy) would pull the economic bloc out of the depths of despair. Instead, the Eurozone periphery (and France) has become a kind of economic quicksand, pulling the German economy lower. Capital markets participants, accustomed to the success of the Fed’s extraordinary monetary policy stimulus, are optimistic that aggressive monetary policy stimulus will restore growth to the Eurozone. Thus far market participants have been disappointed on two points: 1) Aggressive monetary policy stimulus implemented by the ECB thus far has not been able to restore economic growth to the Eurozone. 2) Monetary policy will not be enough to reverse the Eurozone’s fortunes going forward. Last week, ECB president, Mario Draghi said that governments must act “urgently” to enact fiscal reforms, adding: “I am uncertain there will be very good times ahead if we do not reform now.” At the present time, it appears that most Eurozone governments are unwilling to make the much needed fiscal reforms and the Eurozone constituency appears unwilling to accept such changes. We agree with Mr. Draghi. All the monetary stimulus in the world is not going to restore sustained growth to the Eurozone without significant fiscal reforms. We hold little hope that China and the South American economies can live up to their potentials unless structural reforms are implemented as well. The problem here is that the respective governments do not appear to want their economies to fire on all cylinders, not at least in the truest sense. Our concern is that asset prices have built in economic rebounds in Europe, Asia and South America which might not materialize as was hoped.