As the Economy Recovers, What Is 'Normal'?Michael McKee
The "new normal" may not be the new norm after all. At least that's the belief of many Wall Street economists, who aren't buying the theory advanced by Bill Gross and Mohamed El-Erian, co-chief investment officers at Pacific Investment Management Co. (Pimco), that the U.S. will be stuck in long-term sluggish growth averaging 2% a year. Instead, the median forecast of 46 economists surveyed by Bloomberg is for potential real growth, or the rate of economic expansion at which inflation is steady, of 2.5%, matching the average rate of the past 20 years.
While the half-percentage point between Pimco's projection and the survey median may seem small, it makes a big difference over time, especially to investors. Expanding by 2.5% a year rather than 2% would leave the $13 trillion U.S. economy larger five years from now by almost an extra $400 billion, about equal to the gross domestic product of Argentina.
Such growth would also likely translate into higher corporate sales and earnings. Kevin Gardiner, head of investment strategy at Barclays Wealth (BCS), says returns on equities historically have been about 7%. "They'll likely be above that for some period," he says. That would be a far healthier performance than the 5% forecast by Pimco, manager of the world's biggest bond fund.
Investors have been betting on that more optimistic outlook. The Standard & Poor's 500-stock index is up 27% since early May, when Gross and El-Erian made their forecast. Government policymakers are hoping for a return to the historical trend, as well. That's because a new normal growth rate would be particularly bad news for President Barack Obama's Administration and Congress as they cope with a budget deficit projected to reach $1.4 trillion in the current fiscal year. Faster growth means higher tax revenue, making it easier to close that shortfall.
The economy was still bumping along the sea floor last spring when the Pimco executives said an extended period of greater government regulation and lower consumer spending would stunt growth for years. Gross domestic product had contracted 6.4% in the first quarter of 2009, and unemployment had just hit a 26-year high.
But while the jobless rate continued to climb, peaking at 10.1% in October, the $787 billion federal stimulus program that took effect in February helped the economy begin expanding in the third quarter at a 2.2% annual rate. And fourth-quarter GDP is on track to rise 5.6%, according to forecaster Macroeconomic Advisers.
The major reason: Companies that drew down stockpiles during the recession are restocking to meet increased demand. Business inventories rose 0.4% in November for a second month after 13 months of decline.
But El-Erian says the turnaround is only temporary. "After an inventory-driven bounce in the GDP growth rate, we are expecting a 2% annual pace," he says. "It will take years for the U.S. economy to recover to the level of GDP attained before the crisis."
Some on Wall Street share that pessimism. Drew Matus, a senior economist at Bank of America Merrill Lynch (BAC), predicts the U.S. will experience faster growth as the recovery builds, but the pace will then slow.
His company sees potential growth of 2.25%, "not substantively different" from Pimco, and down from a 2.75% estimate before the recession began in December 2007. "When people talk about the new normal, they're not talking about 2010 or 2011, they're talking 2013 and beyond," says Matus.
While Stephen Stanley, chief economist at RBS Securities (RBS), has also trimmed his growth estimate, to 2.6% from 2.75%, he rejects the idea that the economy is permanently different. That's because he figures potential growth comes from increases in productivity and in the labor force, which rises with the population, and "the business cycle doesn't change that."
Robert MacIntosh, chief economist at Eaton Vance Management (EV), is even more optimistic. He pegs long-term expansion at a robust 3.75%, but for a more basic reason. Explains MacIntosh: "We're still Americans, and we're still going to consume."