Depending on who you ask, you may get a very different answer when you ask how the economy is doing. “Official” stats show a fairly robust economy that is still expanding. Real GDP growth has been in the 2.5% range, which is pretty much in line with the 10-year average. Unemployment is at 4.3%, which is fairly low in comparison to historical levels. Inflation has been coming down after a big spike in 2022. So why do polls suggest that the average American is not feeling as good about the economy? Let’s take a closer look at GDP, unemployment and inflation.
Thinking back to Econ 101, GDP is computed as Consumption + Investment + Government Spending + Net Exports (typically a negative number since the U.S. exports less than it imports). When looking at changes to GDP, the composition of these underlying figures is important. Arguably the least valuable of these components is government spending, yet with the deficit running at ~7% of GDP in a full employment economy, it is currently driving GDP growth. On the flip side, investment is the engine of future growth, but it seems to be stalling, increasing by just 2.7% cumulatively over the past two years.
Next, we’ll turn to unemployment. Though relatively low, a closer look suggests that government hiring is primarily behind the fairly strong employment numbers. Over the last two years, government employment has grown at a ~3% rate while private employment has grown at a lower rate, which is in contrast to most of the past decade. Government employment does not add to the productive capacity of the U.S. economy and, in fact, some would argue it slows things down.
U.S. Employment Growth
Finally, a closer look at inflation versus wages, which is likely the most important issue. The year-over-year rate of inflation peaked at 9% in June 2022. It has since fallen to about 2.9%, but while the inflation rate has fallen, prices are still rising. In fact, the consumer price index (CPI) is almost 17% higher over three years according to the St. Louis Fed. Wages have barely kept up, with real wages about flat over the past three years. Wage growth generally exceeds inflation, however, the spike in inflation that started in 2021 inverted that relationship for the next two years until wage growth caught up. Over the past three years, after inflation, many workers are barely treading water.
As financial advisors, why do we care about this? In short, it comes down to risk management. At some point, the U.S. economy will experience the downside of the economic cycle. The future is always uncertain, which is why we aim to build diversified portfolios that are expected to do well in many economic environments. As such, we like to approach the uncertain future with the equivalent of an all-terrain vehicle portfolio that will get us to our destination in all types of weather, rather than a hot sports car portfolio that may end up on the side of the road in inclement weather.
Special thanks to Ancora intern Michael Mattimore for contributing to this article.