I want to be an optimist for 2014 but it is hard to think that way when you look at the facts of the current US economy. There are positive signs in the current economic environment, but how much of this is truth or just the desire to feel better as we start the year.
To provide context for 2014, we have to start with the major theme that is overhanging the global economy, deleveraging. We were and are still in a balance sheet recession adjustment process. The data that we have on balance sheet recessions is that it may take more than five years to fix the system. A balance sheet recession needs to work through the excesses in the economy. We are doing it at a rate that is consistent with history. We may not like this but it is reality.
We have followed a growth path of around 2.3% since the beginning of the recovery. We are below the long-term growth path and continue to have a large output gap. This is unlikely to be closed in 2014. Global GDP has been revised down by the IMF to 2.9% in 2013 and 3.6% in 2014. This is not a launch pad for a stronger recovery.
The labor markets are not in good shape and household income is 9.1% below the highs set in 1999 and still over 8% below pre-recession levels. People are not in better income shape, so the driver of consumer spending is not present. Yes, balance sheets have improved, but this is through belt tightening, lower rates, and bankruptcies which wipeout debt.
Interest rates are being kept low, but there is a fiscal drag in the US economy. The deficit has moved from over $1 trillion to a level that will be closer to just under $700 billion. Fed employment is declining. State and local job growth is still below past highs. It does not seem likely that we will get any fiscal help over the next year. Regulation uncertainty will provide a drag on growth.
The forward guidance from the Fed is that rates will be kept low even if we move through the 6.5% unemployment rate. We will see low rates even if we go to 6% unemployment, but that does not mean that monetary policy will help with job creation.
Inflation is below the 2% target for the Fed. The benchmark PCE is at 1.2% and does not show signs of moving higher in the near-term. Labor cost are low, commodity prices are low, and firms have little pricing power in this economy. The Fed wants inflation but has been unable to create it.
The stock market does not seem to have the environment necessary for significant increases in 2014. Profits for the third quarter are above 9.5% but revenue ha sonly increased by 2.7% YOY. Net income is at the high end of ranges at 14.9% but sales are only increasing 5% YOY. This means that gains are coming from cost containment and lower interest expenses. This cannot continue forever. The gains in stocks are coming form jumps in the P/E ration not earnings. Risk is at low levels as measure by the VIXX index, but given the level of uncertainty in the markets, it is unclear that this also can continue.
This is gloomy but it is the reality of what we are dealing with. We can have some good news that will create optimism in markets, but we want to be more careful concerning any view of growth opportunities.