What is GDP per capita? It is the value of all goods and services produced in an economy divided by the number of people living in it. Why is it important? It is one of the premier ways to identify both the comfort level of a country’s citizens at a given moment in time as well as the well-being of citizens over time.
At the present moment, people living in the United States have it pretty good. Not quite as good as those who live in Switzerland, Norway or Hong Kong, but better than those in Canada, Japan or Germany. GDP per capita in the United States? $57,220.
Perhaps more importantly, inflation-adjusted GDP per capita has been growing at a noticeably slower pace since 1980. Real GDP per capita for the 50 years prior to 1980 averaged 2.4%. Since then? 1.7%. It has averaged a less-than-robust 1.4% in the current economic recovery (5/09-12/16).
The picture becomes uglier when one evaluates the growth slowdown in 10-year blocks. (See below.) Reagan and Clinton may have had some successes in the 80s and 90s, but neither altered the overall trajectory. If Reagan, Bush Sr., Clinton, Bush Jr. and Obama could not alter the downward path, what can Trump do to provide a sustainable standard-of-living uptrend for the American people?
According to Gallup, the decline is a direct function of soaring costs in three sectors: education, housing and health care. For example, the research found that all goods and services have risen in price 2.5x since 1980. Call this the inflation rate (2.5%). Yet education has catapulted nearly 9x in the last 35 years alone. Indeed, when I attended Arizona State University in the mid-80s, I paid about $1200 in annual tuition fees. Care to wager an estimate on the tuition that we pay for my daughter’s in-state experience at UCSD? Excluding books, room, board and supplies? $13,573 per year. That’s close to 11 times more pricey than when I pursued an undergraduate degree.
I doubt that I need to chronicle the health care debacle. In brief, health care has pole vaulted 5x since 1980 or 2x the rate of overall inflation (2.5%.).
Housing may stimulate the most intrigue. For instance, renters coughed up roughly 19% of income to service rent payments in 1980. Today? 28%. And some of the lowest mortgage rates in history have not lowered the percentage of family income that homeowners must allocate to a mortgage (16%). In 1980, with double-digit 30-year mortgages being the norm, only 12% of family income went toward servicing the debt.
Think about this for a moment. All of the rate manipulating in the world since the 1980s – all of the efforts to push interest rates lower and lower during the era of Greenspan/Bernanke/Yellen at the Federal Reserve – has led to higher mortgage servicing. That’s because the Federal Reserve’s actions have pushed the prices of key assets higher (e.g., stocks, bonds, real estate, etc.) over three-and-a-half decades, while doing precious little to benefit the typical American household. The typical American family is less concerned about Dow 20,000 than meaningful gains in take-home pay.
Even the chart above does not tell the whole story. Inflation-adjusted household income may be a mere 0.6% less than it was at the start of the century. And on that measure, Americans have not lost significant ground since 2000. One must remember, however, that real household income has been adjusted for the above-described inflation rate of 2.5%. Unfortunately, the cost of education, housing and health care have skyrocketed relative to the official inflation data. Median household income in 2016, then, simply does not stretch anywhere near as far as it did in 2000 or 1980.
“But Gary,” you protest. “Dow 20,000 is a reflection of the pro-business improvements coming down the pike. And everyone will benefit from the corporate tax cuts to the fiscal stimulus to the reduced regulatory burdens.” Maybe.
On the other hand, higher interest rates and a higher U.S. dollar damage the case for stocks that are already trading at stratospheric valuation levels. Worse yet, demand for rate-sensitive home and auto are likely to slow. The euphoria for a pro-business administration is unlikely to endure if the easy access to inexpensive money is significantly compromised.
Indeed, one might not have to look further than the dramatic decline in mortgage applications. According to the Mortgage Bankers Association, applications decreased 4% from a week ago, following a 7% decline the week prior and 9.4% the week before that. The largest culprit may be the pool of borrowers who would benefit from refinancing. It went from eight million prior to the election to four million today. That is what happens when a 30-year conforming goes from 3.5% back in July to 4.25% in mid-December.
How do you think this will play out if the 30-year makes it to 4.5%? or 5%? Or 5.5%? It may very well have an adverse impact on household-net-worth-to-GDP. Housing prices would likely flatten or dip. And stock prices? Tighter financial conditions this far into a business cycle are probably not going to be a boon for highly leveraged corporations. Bubble or balloon… some air might seep out of central bank inflated asset prices.
Since the end of the final asset purchase of QE3 on December 18, 2014, I have been “bearish” on equities. I put “bearish” in quotation marks because anyone who actually reads my commentary understands that I made a tactical asset allocation shift two years ago. I shifted most of my moderate growth-n-income clients from 70% widely diversified stock (e.g., large, small, foreign, etc.) and 30% widely diversified income (e.g., short, long, investment grade, higher-yielding, domestic, foreign) to 50% high quality equity/25% investment grade bond and 25% cash equivalent.
In fact, that shift has performed rather well across the time span. Consider Vanguard High Dividend Stock ETF (VYM) over two years, a core high quality holding, versus the widely diversified Vanguard FTSE All World (VEU). Less risk. Less volatility. Greater risk-adjusted gain.
Shifting away from riskier bond holdings hasn’t been quite as beneficial. That said, the move avoided the uncertainty as well as the volatility that came with junkier income assets. The ride in iShares Corporate Credit (CIU) has been less of a roller coaster than the ride aboard SPDR High Yield Junk Bond (JNK); the two had been neck-n-neck up until the election.
Is it fair to criticize the 25% cash component that, for the most part, has been intact for nearly two years? Sure. Why not. Investors should keep in mind that the collective performance of all stocks on the New York Stock Exchange (NYSE Composite) has not been particularly breathtaking since the end of QE3 in December of 2014. Then again, perhaps I could have “bought” the August 2015 correction or the January 2016 free-fall.
Profitable trading possibilities notwithstanding, I do not view the 25% cash allocation as a drag. It has buffered against gut-wrenching volatility. More critically, it affords one the luxury of acquiring assets at significant bear market discounts.
Rapid-fire traders may be looking for a quick hit in the next correction. Me? I believe there will be a better opportunity for cash. I look forward to the stock market equivalent of real estate’s “short sale” or foreclosure.
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