The Independent Market Observer | Outlook. Opinion. Insight.

3/8/13 - The Bull Case for the U.S. Economy

Written by Brad McMillan, CFA®, CFP® | Mar 8, 2013 3:10:20 PM

I want to do something today that I do not do that often: make a specific case for something. Ordinarily, economics is very much a nuanced “on the one hand/on the other hand” subject—to the extent many wish for a one-armed economist. Today, though, I want to make the case for a strong U.S. recovery.

Let me be clear. I am not pounding the table on this. I still don’t consider it the most probable case, and there are certainly enough factors out there that could derail it. The news keeps surprising to the upside, however, and I think it makes sense to look at how we could continue to be pleasantly surprised as the recovery starts to gear and turn really strong.

Let’s start with employment. Private sector employment is growing at an accelerating rate, as we heard most recently this morning. Although federal government employment will be taking a hit, state and local government employment should start to pick up that slack. Overall, employment is improving and doing so at an accelerating rate. Which should lead to . . .

Wage growth has been modest over the past couple of years, but if you look at history, when the average hours worked per week hits a certain level, it takes off. We are now at that level, and unit labor costs are starting to rise, which means more income for the average worker. This is a trend that is also set to accelerate, which should lead to more consumer spending.

Consumer spending is two-thirds of the economy, and it has continued to grow despite the tax increase at the start of the year, despite the increase in gas prices, despite everything. When wage income starts to rise at an increasing rate, there will be even more income available to spend, which in turn will drive business spending to keep up with production, inventory, and everything else in that virtuous circle.

Consumer borrowing, which has been the other driver of spending growth, is also looking to pick up. Banks are as healthy as they have been in years, consumer debt is at multiyear lows, and debt service levels are even lower—and people are starting to borrow again.

Besides income, wealth is now at multiyear highs. With recoveries in the equity and housing markets, many consumers have now regained much or all of the wealth they had at the peak. I personally find the wealth effect on spending unconvincing, but as a confidence booster to support income-driven spending, I am convinced, and this is one more piece of the puzzle.

All of this consumer spending is not just driven by an urge to splurge but by pent-up needs. Auto sales are growing as the average age of the U.S. fleet is at a very high level. Truck sales, for example, are being bought by workers who are building houses (as that market comes back); they have not been able to afford them for years—and they need new ones. Housing is being driven by people who want to start their own households and have not been able to. Much of the increase in demand is driven by needs, not wants, which should make it more durable.

Rising consumer demand is also supporting growing business investment, another big piece of the recovery puzzle. Government spending, declining at the federal level, is recovering at the state and local level. Even exports are doing relatively well.

All of these positive trends have occurred in the face of continuing political uncertainty, tax increases, rising gas prices, and other significant headwinds. At a certain point, the headwinds will fade, and then it is reasonable to expect the economy to strengthen even further. We really are getting there, and barring external shocks, I believe a series of upside surprises is quite possible.

That said, external shocks are likely. China, Europe, the Middle East, Washington, DC . . . the list of possible problems goes on and on. Even if and when one or more of these hit, though, the fact is that the strength and broad-based nature of the recovery should allow growth to continue—and to speed up again when the headwinds start to fade.

I wrote this specifically to make a case, and I believe it is a strong case. Not, as I said, the most probable case, but considerably more so than it was a couple of months ago. My hope is that I will revisit this in a couple of months and be able to make an even stronger case.