What really matters: the drivers of today’s economy
Every day we are bombarded with data and opinions meant to help investors manage their portfolios. Much of the data can be ignored, because unfortunately most of it is just that—data. As investors, we only want to explore the kind of data that becomes useful information. My team and I will figure out what you need to know to grasp where the market is heading by uncovering what really matters when forecasting economic activity. In a world where a constant stream of economic data and commentary is the norm, it’s crucial to be able to sift through what really matters to make better-informed investment decisions.
The important variables to monitor over the next year will be the U.S. dollar, employment and key global issues.
I visited The Street‡ recently to share my insights.
The U.S. Dollar
The U.S. dollar (the dollar) has become increasingly important because of two key functions.
1) its impact on corporate earnings in the United States.
2) global economic conditions and its ability to provide insight into relative interest rates.
Let’s take a look at the short-term and long-term impact of the dollar on the economy.
With the recently-strengthened dollar, the fast increase is what had a meaningful impact on our economy. A strong dollar makes exported goods and services that are produced in the United States more expensive. Numerous conglomerates have cited the strong dollar as a headwind that has negatively affected corporate earnings, stating that this will be a driver putting downward pressure on earnings and stock prices due to the translation impact1 and competitive concerns2. However, small businesses which typically do not have as much international exposure will not be as negatively affected by a strong dollar. Also, the United States is a net importer; in the first quarter we exported $2.08 trillion and imported $2.63 trillion. Commodities are negatively correlated with the dollar and as it strengthens, commodity prices will fall. This will be a positive for companies that use commodities as an input variable and for the general consumer. We expect continued strength in the dollar.
We see that the dollar typically strengthens when the U.S. economy is outpacing its peers. In addition, we think the United States will soon be hiking interest rates while lowering rates is popular elsewhere around the world. This would suggest more upside for the dollar. However, we think Europe will show signs of economic growth and this should cause the dollar to stabilize. It is imperative that we pay attention to the dollar. It matters more than investors realize.
To learn more about the value of the U.S. dollar, check out my video from earlier this year.
Jobs are one of the most important variables to an economy. As jobs are created, consumer confidence increases and over time, wages increase.
What matters are jobs, jobs and more jobs. Job creation is the critical component in breaking the U.S. economy free from being “stuck in the mediocre-growth-mud.” In the short run, it is not critical what kinds of jobs are created, or whether they are high or low paying. Rather, it’s more important to focus on job growth and a low unemployment rate. Those variables alone will increase consumer confidence and move the markets. This year we expect that an average of 250,000 jobs will be created per month, similar to 2014.
The quality of jobs and wage growth remains in question. It appears there are some structural changes developing.
The U-6‡ is one of the ways the Bureau of Labor Statistics more critically measures long-term growth. The U-6 is calculated by adding the marginally attached workers (people who have become discouraged and stopped looking for employment) and part-time workers to the unemployment rate. This puts the U-6 at 10.8 percent, almost twice the rate of the unemployment rate (5.5 percent).
The jobs created have been in lower-paying industries, such as retail and leisure and hospitality. In addition, part-time employment due to economic reasons has not improved since 2010. This indicates a skill mismatch and a potential structural change developing.
The labor market appears to be tightening; unemployment has improved significantly since 2009, yet there appears to be limited wage pressure. We think once the U-6 breaches 10 percent, wage inflation will appear on the horizon. Employment matters.
Global Gross Domestic Product (GDP)
We operate in a global economy. What happens overseas can have a material impact on the U.S. economy.
All eyes are on Europe. Whether Europe can successfully manage Greece and enter a recovery phase is up in the air. Europe’s economy has been growing very slowly. Similar to the United States in 2009, lower interest rates and quantitative easing by the European Central Bank‡ are now critical to global economic and market activity. Approximately 10 percent of our exports go to the Eurozone‡. The consensus GDP growth in Europe is 1.5 percent in 2015. As monetary stimulus and green shoots of growth sprout in Europe, risk-based assets‡ should perform well around the globe.
China is important to the global economy for two primary reasons:
- China represents the second largest economy in the world. The U.S., the largest economy, has a $16.8 trillion economy, while China’s economy is only $13.3 trillion.
- Even more important than size is growth rate. In 1985, China represented 3 percent of global GDP and the U.S. represented 25 percent. Today, China represents 14 percent and the U.S. has dropped to 19 percent. Even though the Chinese economy is smaller than the U.S. economy, it has been growing at a faster pace. In 2010, China was growing at a pace of 10.5 percent. Growth in 2014 slowed to 7.4 percent, although the data from their government has been questioned by many.
The real risk is if China’s economic activity slows to less than 6 percent growth. For a country with 1.4 billion people a slowdown would send a ripple throughout the world’s economy, as China’s imports will wane. We operate in a worldwide economy and ignoring these global variables is not an option.
Remember to check back for “What Doesn’t Matter: The non-drivers of the economy” next week!
 Translation is negatively impacted because sales generated outside the U.S. must be converted into dollars for financial reporting purposes. Therefore, a higher dollar = lower sales in dollars. So focus on sales ex-currency impacts.
 Example: Airbus, a European airline manufacturer, becomes price competitive versus Boeing, a U.S. airline manufacturer when the Euro weakens relative to the Dollar.
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K.C. Mathews joined UMB in 2002. As executive vice president and chief investment officer, Mr. Mathews is responsible for the development, execution and oversight of UMB’s investment strategy. He is chairman of the Trust Investment, Asset Allocation and Trust Policy Committees. Mr. Mathews has more than 20 years of diverse experience in the investment industry. Prior to joining UMB, he served as vice president and manager of the portfolio management group at Bank of Oklahoma for nine years. Mr. Mathews earned a bachelor’s degree from the University of Minnesota and a master’s degree in business administration from the University of Notre Dame. Mr. Mathews attended the ABA National Trust School at Northwestern University and is a Chartered Financial Analyst and member of the CFA Institute. He is past president of the Kansas City CFA Society and a past president of the Oklahoma Society of Financial Analysts.