17 Jul Quarterly Letter to Clients – July 2019
We have noted in past letters the importance of business labor productivity for the strength and growth of the economy. When output per man hour goes up, so does our overall standard of living. As a result, there has been legitimate concern about relatively anemic productivity figures reported in the present decade. In the 1980s and ‘90s, rapid productivity growth – and rapid economic growth – were fueled by the success of new businesses in information and communications technology, including corporations such as Microsoft, Apple, Amazon, Intel and Google. These companies not only created millions of jobs, but also changed how many world countries produce, distribute and market goods and services. In this environment, productivity increases were averaging 2½ to 3½%.
Unfortunately, in the current decade, there have been no developments with such a transformational impact and annual productivity increases slumped to a 1.25% average. Some economists have expressed the view that productivity has probably been impacted by excessive government regulation as well.
It will be a serious concern if productivity growth continues to be far below historic averages. Living standards will rise more slowly; tax revenues will be lower; and the burden of paying today’s debts heavier. In such an environment, stocks are likely to provide total returns lower than their long-term average.
Given this rather somber picture of latest ten-year statistics, the first quarter provided a pleasant surprise – a 3.4% productivity rate, representing a 3.9% increase in output and a 0.5% increase in hours worked. An extremely low rate of unemployment, 3.7%, was no doubt a factor, but there are hopes that more fundamental stimuli are raising these figures as well.
Although long-term productivity trends remain a real concern, the U.S. economy has continued to show considerable strength. This was underscored by the release of the monthly new jobs report on July 5, which showed a very healthy addition of 224,000 jobs in June, up from a lackluster 75,000 total in May. Stocks reacted negatively because of fears that such strength would push the Fed to a more restrictive credit policy.
In spite of positive signs like this, many economists believe the use of tariffs and economic sanctions by the Administration will be a growth retardant that also hurts corporate earnings. This could be part of the reason, at least, that consensus projections have been for lower earnings in each of the first three quarters of 2019.
This is likely to be a particularly challenging environment for investment managers, one in which it will be even more difficult than usual to find companies for investment which will do better than the pack – probably those which are likely to show impressive revenue growth, high return on equity and strong stock performance. Stocks should not be abandoned – only great care used in their selection.
Enjoy your summer!
Peter J. Connors, CFA
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