The Independent Market Observer

1/31/14 – The New New Normal

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Jan 31, 2014 10:22:41 AM

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I gave a talk here at Commonwealth yesterday, updating our staff about the economy and the markets. One point kept coming up over and over—that we’re now at or close to normal levels of growth, as of the mid-2000s, which was a pretty good time. In some areas, such as employment, we still haven’t returned to normal levels in total, but getting normal growth is the first step.

(As an aside, this type of internal training and education is part of what makes Commonwealth exceptional. Everyone is welcome, and these talks happen all the time on many different subjects.)

That’s not to say we’re completely out of the woods. Employment, as I mention above, still has a ways to go, for instance. In many respects, though, the economy (although not the stock market) has returned to normal—a major and very underappreciated triumph.

Let’s think about the real goals the Fed had, or should have had. In 2008, the idea wasn’t to bring us back to boom times; booms inevitably lead to busts, which in 2008 was pretty apparent. The goal was to bring us back to normality, steady and sustainable growth that didn’t rely on gimmicks.

If we look at employment, for example, we can see that private employment has actually been at the normal levels of the mid-2000s for some time. The problem has been government layoffs, which are subsiding, per the following chart.


An important distinction between now and then, though, is that this time the hiring is driven by an economy that doesn’t rely on unsustainable borrowing to boost consumer spending, but instead on actual income growth.

Wage income, which is most of consumer income, is also growing at the rates of the mid-2000s, even as spending is growing at a somewhat slower pace. Wage income is increasing faster than jobs, because hours worked and hourly wages have also increased, along with the number of jobs. Again, from a worker income-growth standpoint, we’re back to the normal of the mid-2000s. The fact that spending is growing somewhat slower than income, again, is a good thing, because it means such growth will be sustainable.


The housing market has also normalized. Housing price growth has returned to positive territory in a big way and is now slowing, which is normal. In fact, it’s a good thing as it means we’re not entering a new bubble. The supply/demand balance, houses sold versus those for sale, is normalizing. In many markets, sales are actually limited by a lack of supply.


Even the headlines for housing now reflect normalization. Some markets are doing well; others are not. The old real estate mantra “location, location, location” is back in force. This is normal and positive. Even what’s not normal—in this case, affordability—is beneficial. It remains much better than normal, which bodes well for house demand and prices going forward.

If you look at business demand, that too has moved back close to normal levels. The chart below is for services, but the manufacturing survey gives similar indicators. Again, the idea is not that we’re completely there, but we are getting much closer than is generally appreciated.


On an aggregate level, looking at the composite economic leading indicators, we reach the same conclusion: normality is getting close, and the trends are in the right direction.


I gave a talk a couple of years ago where I outlined how the U.S. was in a much better competitive position, with respect to other countries, than was generally thought at the time. I ran through our advantages in demographics, geography, natural resource availability, and other factors, and concluded that our only real weakness was the deficit, which would be dealt with. As of now, that has pretty much played out as I expected, even though the deficit adjustment has been painful.

Even as I say we’re in pretty good shape, and getting better, from an economic perspective, there is one outstanding issue: the valuation of the stock market. This is the only major area that hasn’t returned to normality—and, unfortunately, the direction back to normal is down. No one knows how or when that adjustment might occur, but if it doesn’t, then things really are different this time. I hope so.

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