Economies aren't subject to gravity, making "escape velocity" a misnomer in economics and market analysis. Photo by Matt Stroshane/Getty Images.
Escape Velocity. In astrophysics, it’s the speed required for an object to break free of the Earth’s gravitational pull. In economics, evidently, it’s something the US has yet to reach—at least, so say many, many, many headlines in recent days. As metaphors go, it’s a bit odd—last we checked, our economy wasn’t a spaceship. Overall, though, it seems to be the latest iteration of the slow growth meme that has preoccupied headlines (and investors) since this expansion began in 2009. It’s true the US isn’t rocketing ahead (pun intended). But it doesn’t need to—or to achieve some hypothetical breakaway speed—for stocks to keep doing fine.
The “escape velocity” jitters rest on a fundamental fallacy: the notion economies are prone to laws of physics. If the US doesn’t start growing faster soon, it risks lapsing back into recession because, well, gravity. If it does grow faster, we’ll break out of the stratosphere and go to infinity and beyond because, well, momentum.
That isn’t how economies work. Laws of physics apply to physical objects. Momentum, gravity, friction and all their brethren don’t apply to economies. There is no such thing as breakaway speed—there isn’t some magical rate of growth that begets more growth ahead. To say there is ignores the near-countless variables impacting output (not to mention the many recessions that have followed robust growth).
It’s certainly true growth has been slow this time around—we’re nearly five years into the slowest expansion since World War II. The government bears some blame, as spending cuts at the federal, state and local levels have detracted from growth since Q4 2009. Strip out the government, though, and the private sector is growing well below average, thanks to the weakest loan growth and broad money supply growth in decades—the fruits of the Fed’s quantitative easing bond buying, which flattened the yield curve and gave the US economy a massive sedative (see here and here for more).
Yet we’re also more than five years into a bull market of above-average length and magnitude. Clearly, five years of slow growth hasn’t deterred stocks. So we’re a touch perplexed by the theory growth has to speed up for stocks to keep doing well. Faster growth would be nice, but stocks don’t need it. Stocks don’t move on growth rates—they move, over time, on the gap between reality and expectations. As slow as growth has been, it has beaten dismal expectations. Corporate profits are at all-time highs and rising. S&P 500 earnings hit another all-time high in Q4, driven by rising revenues. Adjusted for inflation, business investment finally passed its pre-recession peak in Q4. Investment in equipment and intellectual property (including R&D) passed their pre-recession peaks in Q4 2012 and Q4 2010, respectively.
With so many private sector indicators at all-time highs (and rising)—and real GDP having passed its pre-recession peak in Q2 2011—it seems bizarre to think we’re still trying to escape some sort of mythical gravitational pull. Sluggish growth is still growth. That nearly five years of it hasn’t given way to recession would seem to be proof enough that escape velocity is neither a requirement or even a thing, but the meme holds. That’s good news, in our view: It means expectations are still pretty low.
Meanwhile, the Leading Economic Index (LEI) accelerated in March, rising 0.8%. It hasn’t fallen since March 2013. No recession in 50 years has started during a rising LEI trend. New orders in manufacturing and services are rising, too—today’s orders are tomorrow’s production. Inventories aren’t rising as fast as sales, suggesting businesses are struggling to keep up with demand. Year to date, intermodal rail freight shipments are up 4.8% over 2013—more goods are on the move. Long-term interest rates have fallen some lately, but the yield curve remains steeper than it was a year ago—about a century’s worth of economic theory and evidence says this is good for growth. Corporate balance sheets remain flush with cash and commercial lending accelerated in Q1, giving firms plenty of capital to deploy looking ahead—fodder for more growth.
Even as folks seem to think the US is at stall speed (which we guess is no speed? Low speed?), the evidence suggests things are chugging right along. Maybe even speeding up, though it doesn’t need to for this bull market to continue. All stocks need from here is what they’ve had for the past five years: a reality that is better than investors, overall and on average, perceive. With stagnation jitters aplenty (and overall investor sentiment muted) even as signs point to continued growth, this bull should keep climbing up the proverbial wall of worry for quite a while.
4 Ways to Avoid Running Out of Money During Retirement
To investors who want to retire comfortably. Download the guide by Forbes columnist and money manager Ken Fisher's firm. It's called "The 15-Minute Retirement Plan." Even if you have something else in place right now, it still makes sense to request your guide! Click Here to Download!