Escape Velocity: What Will Fuel Our Economic Breakout?

Escape Velocity is simply the speed required to escape gravity’s pull. An object on earth’s surface would need an initial speed of 6.96 miles per second (Mach 34) to get out of the gravitational range of the planet.

As we continue to recover from the 2008 recession the question looms; “What will it take to escape the unseen gravitational pull of what is called the new normal economy?”

Slow economic growth has given Americans a feeling that the economy is destined to grow at 1 to 2 percent. The decades-long average prior to the 2008 recession was 3 to 4 percent.

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Let us be clear. This article focuses on the economy, not the stock market. The market as measured by the S&P 500 formed a bottom 5 years ago. That index has reached around 50 all-time highs in the last 12 months. From January 1, 2009 to January 1, 2014 the S&P 500 went up over 100 percent.

Should it bother investors that the market has been making new highs? No, making new highs is normal for American stocks. Should we worry that five years is too long for a bull market? No, it is a healthy sign to have long periods of growth interrupted by smaller drops.

The question is “How long can the bull market in stocks last if the new normal continues?” Furthermore, what kind of rocket fuel will propel this economy beyond its current trajectory?

As the Federal Reserve stimulus winds down, something else will have to take its place. The U.S. economy needs to transition from a government-induced to a consumer-driven expansion.

Can consumers afford to spend any more? It has taken a long time, but unemployment levels are getting closer to pre-recession levels (currently 6.7 percent). Household debt payments are at an all time low as a percent of income, which is also really good. Unfortunately, the average income of American households is one economic measure showing no improvement over the last 5 years.

Household income may be the most important ingredient to current growth. It may improve soon. As unemployment numbers get stronger, the labor market will tighten. Employers will raise pay for their workers. When that begins to happen in the U.S. workforce, consumers will finally have more spending power to propel the economy.

While stock returns have been great in recent years, they cannot rise forever without better economic growth. The gravitational pull of the new normal is just too strong. Keep an eye on improving income in the United States. It may fuel the next breakout.

As the Sochi Olympics ended, many eyes turned to the other side of the Black Sea and the threat of war in Ukraine. With each successive turn of good or bad events, our U.S. stock markets1 seem to react in like manner. That begs the question, what impact do wars have on stock markets, and how should an individual react?

To see the impact of war, let’s first examine the most recent war that started on American soil. The impression that many people have is that the recession of the early 2000s started with the terror attacks on September 11, 2001. The reality is that stocks were already on a downward trend when September 11th happened. Yes stocks dropped sharply in the 10 days following that awful event, but once America grasped the reality of the situation, stocks rebounded, recovering the losses directly related to the shock of that event.2

There is a similar pattern for each conflict involving the United States. “In 14 shocks dating (back) to the attack on Pearl Harbor in December 1941, the median one-day decline has been 2.4%. The shocks, which also include the September 11th terror attacks and the 1962 Cuban missile crisis, lasted eight days, with total losses of 7.4%…The market recouped its losses 14 days later.”3

Similar patterns of decline occurred during several Middle Eastern conflicts such as Desert Storm in 1991, the Iraq War in 2003, and the Syrian Conflict in 2011. Leading up to each of these events, the market dropped, but recovery happened shortly thereafter.4
Mark Luschini, the Chief Investment Strategist for Janney Montgomery, put it this way, “It’s not that it’s welcome, but once it gets underway, you can quantify what the situation might look like. When you’re left in the dark about when it will start, what will be the result, it gives investors trepidation.”5

Short-term shocks to the system cause short-term consequences for the stock market and the economy. On the other hand, major periods of conflict can have more lasting effects on the economy and the stock market.

One of the most harmful economic effects of war is a supply shock. A major shock in the supply of goods or labor can severely impact economic productivity. Sources of these setbacks include economic sanctions, manufacturing destruction, infrastructure damage, etc. This has not been a factor of major concern within the United States as it has been a long time since there has been a war fought on American soil.

Public opinion supports the belief that war and its associated spending creates positive economic outcomes for the U.S. economy. This is mostly due to the higher GDP growth that was exhibited during conflict periods like World War II, the Korean War, the Vietnam War, and the Cold War. The only outliers have been the Iraq and the Afghanistan wars.6

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While war tends to generate some positive economic benefits, it is more of a mixed bag for stock markets. “During WWII stock markets did initially fall but recovered before its end, during the Korean War there were no major corrections while during the Vietnam War and afterwards stock markets remained flat from the end of 1964 until 1982.”7

Another typical impact of major conflicts is inflation. This is due to the increase in government spending through various financing methods. “While inflation may be good for reducing debt burdens, high inflation has many harmful effects, such as wealth redistribution and erosion of international competitiveness.”8

Short-term conflicts typically have a short-lived impact on the stock market. As such they shouldn’t change an individual’s investment philosophy or cause one to “abandon ship.”

A more prolonged conflict may cause an individual to take a more judicious approach by reevaluating his or her goals and making adjustments based on the current market environment. As always, it is prudent to seek advice from an experienced investment professional that can help you plan for and navigate your own voyage through our uncertain world.

*Research by SFS. Data is from the Federal Reserve Bank of St. Louis. Investing involves risk, including potential loss of principal. The S&P 500 index is often considered to represent the U.S. market. One cannot invest directly in an index Past performance does not guarantee future results. The opinions and forecasts expressed are those of the author and may not actually come to pass. This information is subject to change at any time, based on market and other conditions, and should not be construed as a recommendation of any specific security or investment plan.

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