"Kee" Points with Jim Kee, Ph.D.

Employment data and ISM manufacturing and non-manufacturing data all point to continued moderate growth in the 2 percent range. Proprietary models that I have followed for some years expect growth to accelerate somewhat to 2.5 percent  for 2013. My thinking has been that U.S. GDP growth in 2013 will be moderately higher than in 2012. Why?


Well, this expansion has been much weaker than average for two primary reasons: (1) expansions  following housing collapses/financial crisis tend to be weaker as the private sector “de-levers,” slowing spending and credit creation, and (2) fiscal policy uncertainty (tax, spending regulation) has risen sharply over the past 4-5 years, moving cash to the sidelines and delaying long-term wealth creating activities like capital spending and hiring.


With respect to the first, private sector delevering, I have seen a lot of research lately that suggests that this phase in the U.S. might be coming to an end. Renaissance Macro Research, for example, makes the case that increases in real estate assets and equity prices have increased the ratio of household net worth (wealth) to income to its highest level since 2008. Another very interesting study was recently published by the Bank Credit Analyst. They looked at prior housing/credit busts in developed economies rather than emerging economies (e.g. U.K, Norway, Sweden, Finland) and found that when the ratio of private debt to GDP had declined, post-crash, to about to where it is now in the U.S, then economic growth shifted upwards onto a higher path.


And with respect to the second, policy uncertainty, I think it is encouraging that fiscal cliff discussions have moved from the “public posturing, private negotiating” mode to mostly private negotiating. That typically means that something tangible is being worked out. This week and next are what it all boils down to, so I think a lot of uncertainty one way or the other will be resolved fairly quickly. The budget ceiling debate (slated to become binding in February) is already moving up in the headlines as the press starts preparing for the next “crisis.” I suspect that if the budget ceiling gets resolved before year’s end then it’s back to European debt, Chinese growth, and Middle East turmoil. It is worth pointing out that these are the same issues that have dominated the headlines this year, and yet the market is up well above average (> 14%) year-to-date.


As an interesting aside, the Bank Credit Analyst report mentioned above suggested that, if growth improves, stock market volatility will decline. The reasoning appealed to me:  it was premised on the notion that low GDP growth makes it easier for any given shock to result in recession, making markets more skittish (hence more stock market volatility). I decided to test this assertion that low growth begets market volatility by looking at stock market volatility and economic growth going back to 1926. Sure enough, high stock market volatility periods (above average) occur amidst low, below-average GDP growth rates of 1.9 percent, while low volatility markets occur during higher, 4.73  percent (average) GDP growth periods. This suggests that stronger economic growth is needed in order to reduce stock market volatility.


Thinking it through a bit further, if low economic growth – and hence magnified susceptibility to shocks -  explains stock market volatility, then it should also explain the performance of safe haven or “tail risk” assets like gold. Sure enough, gold price increases are twice as high during high stock volatility, low growth periods then during low volatility, high growth periods.