Must-Read: Gavyn Davies: Why Hasn’t the Productivity Crisis Caused a Bear Market (Yet)?

Must-Read: This by the very sharp Gavyn Davies seems to me to be wrong. An ebbing of the current shortage of risk-bearing capacity would produce a further boom in equities. Central banks’ focus on a 2%/year inflation target makes it very difficult to envision any improvement in the economy leading to be a rapid increase in the wage share. Some unknown future negative shock to the economy could certainly produce a large bear market in equities. But a return to more normal risk attitudes in markets and a continuation of business-as-usual are very unlikely to do so:

Gavyn Davies: Why Hasn’t the Productivity Crisis Caused a Bear Market (Yet)?: “The 2016 calendar year may well see productivity growth in the US economy slumping to around 0.5 per cent, a catastrophic outcome…

…The productivity slowdown has often been called a ‘puzzle’, because it has coincided with a period of rapid technological change in the internet sector…. [But] many of the obvious benefits of the internet revolution appear to increase human welfare without leading to increases in market transactions and nominal GDP. Furthermore, there are several other plausible reasons for the productivity slowdown, including low business investment and a loss of economic dynamism since the financial crash. There is however a different puzzle connected to the productivity slowdown. Given that it has greatly reduced the level and expected growth rate in nominal GDP, why has it had so little apparent impact on equities, an asset class that depends on the level and expected future growth of corporate earnings?…

The conclusion is that the damaging impact of the productivity slump on the S&P 500 has so far been masked by other factors, but there are signs that this might be changing…. The drop in productivity growth has been accompanied by a decline in the yield on safe assets (government bonds), so the discount rate to be applied to future corporate earnings and dividends has declined…. There are however some other reasons…. The share of profits in the economy has risen to historic peak levels, and the dividend payout ratio has also increased…. So does this mean that investors can sit back and relax in the face of a productivity crisis that will clearly damage the outlook for the global economy very seriously? I doubt whether this aberration can last forever. The decline in the real bond yield may be reaching its limits…. And the sharp falls in the unemployment rate, especially in the US, could cause greater wage pressure and a decline in the profit share in GDP…

June 13, 2016


Brad DeLong
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