For twenty-odd years, investment spending by companies has lagged, which has caused economic growth (GDP) to become more dependent on consumer spending. However, consumers are now showing signs of financial stress. So, unless investment spending picks up, a recession is likely.
Contributions to GDP over the past 50 years, by component
|Average annual share of GDP %||Consumer expenditure||Investment||Net Exports||Government Spending||Total GDP|
Companies can spend money on manufacturing plants, equipment and products, buy another company, pay down debt, or buy back their own stock. Only spending on plants, equipment and products transmits directly into economic growth.
However, for the past five to ten years, stock buybacks have been the preferred spending method. Stock buybacks cut the amount of outstanding stock that boasts the earnings per share, thus causing companies to seem more profitable.
Today, many executive salaries are paid in stock, and their level of stock compensation depends on earnings per share. In 2013, the corporations in the Standard & Poor’s 500 index spent $477 billion on stock buybacks. Moreover, those companies bought back that stock after the stock market had increased over 100%.
Many economists believe that, if consumption and government spending drop, corporate investment will automatically rise. However, sometimes, the world is messier than an economist’s model.
The national deficit, as a percentage of American GDP, peaked at 9.8% in 2009. By April of 2014, the CBO projected the debt would amount to 2.8% of GDP.II The deficit usually falls during an economic recovery, but it has fallen exceptionally fast during the current rebound
Higher taxes and fewer benefits cause deficits to fall more quickly; however, both cause consumers to have less money to spend, which leads to lower consumption. This increases the odds that the negative first-quarter GDP was not a fluke.
In the first quarter of 2014, the trade imbalance shaved 1.53 percentage points off of the GDP. The April and May numbers were only slightly better. Europe is a basket case where some countries are experiencing 27% unemployment, so it seems unlikely that exports to Europe will be increasing any time soon.
Also, Europe is experiencing its version of austerity—which is an interesting theory. Some economists believe that if the size of government is cut, people will start spending more because they will realize that smaller government means fewer taxes in the future.
We’ll see about that.
We’ll see about that.
The U.S. has become dependent on consumer spending for economic growth. Debt has fueled much of that spending. In fact, from 2000 to 2007, the overall amount of American household debt doubled from $7 trillion to $14 trillion. In April and May of 2014, real consumer spending turned negative. Falling consumer spending increases the odds that the negative first-quarter GDP was not a fluke.
These are the opinions of financial advisor Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice.