The Three Ds: Disruption, Discontent and Deceleration
The digital economy accelerated economic growth in the United States during the 1997-2017 period. The disruptive nature of technology at the same time led to social discontent as the wages, job opportunities, and labor productivity favored those contributing to the growth of the digital economy. In spite of the economic contributions of the digital sector in the United States, we nevertheless anticipate overall gross national product growth to slow in the coming years under the weight of demographics and debt.
Disruption: The digital economy, defined by the Bureau of Economic Analysis (BEA) to include digital-enabling infrastructure, e-Commerce, and digital media communications technologies, has outpaced overall growth by a wide margin in the United States. BEA estimates that the digital economy grew at an average annualized rate of 9.9 percent from 1997 to 2017 compared with 2.3 percent growth in the overall economy. In 2017, it accounted for 6.9 percent ($1,353.3 billion) of current-dollar GDP*. This compares with, and is just slightly greater than, traditional U.S. industries such as wholesale trade at 6.0% of GDP (see Chart 1). Employees working in the digital economy earned $132,223 average annual compensation in 2017 compared with $68,506 average annual compensation per worker for the total U.S. economy. Given that the United States as a developed country must generally innovate to remain competitive in the global marketplace, as well as provide continued economic opportunity for its citizens, the digital economy has afforded increased opportunities for some. At the same time, the changes have been highly disruptive. This suggests the implicit need for guardrails to ensure a supportive transition for those displaced.
Discontent: As economic disruptive forces take hold, winners and losers emerge. The digital economy has enabled productivity and cost enhancing opportunities, while at the same time leading to the loss of some middle-income and lower-income paying jobs. In addition, growth in the “global economy” has exacerbated the loss of specific industry job opportunities. The steel industry is one example as shown below in Chart 2.
This social discontent has yet to be comprehensively and productively solved. Until it is, we expect continued social unrest.
Deceleration: Total U.S. Federal debt at greater than $22 trillion with the U.S. budget deficit moving rapidly toward $1.0 trillion per year is unsustainable over time. By 2029, the Congressional Budget Office projects the deficit will reach approximately 4.7 percent of GDP as shown in Chart 3.
Public debt at high ratios to GDP tends to reduce the ability of a country to grow compared with what it otherwise would. Just as important is the cost of servicing that debt.
While recent jobs and employment reports have been strong, inflationary tendencies have remained low due in part to the digital economy and slowing growth in other parts of the global economy. Trade negotiations, including potential tariffs, have negatively impacted global growth as manufacturers plan for a range of outcomes. The exorbitant privilege of reserve currency status and low inflation in the United States has led to downside fluidity in interest rates. The Federal Reserve is on hold in terms of ratcheting up the federal funds rate.
The combination of the outlook for deceleration in U.S. economic growth and the reversal of interest rate direction enables us to revisit the stable, restorative conditions of slow growth and low interest rates, which together lend support to higher equity valuations.
Conclusion: In the short term, corporate disruption, social discontent, and economic deceleration are both constructive and destructive. This bimodal impact lends itself to “risk on’ and “risk off” financial asset volatility. The change in direction of equity returns from the fourth quarter of 2018 to the first quarter of 2019 reflects evolving investor perceptions of the impact of slowing economic growth. Whereas the S&P 500 Index declined (13.5%) in the fourth quarter of 2018 on recession concerns, the S&P 500 Index rebounded in the first quarter of 2019 by 13.7%. During both 4Q2018 and 1Q2019, interest rates eased downward as it became apparent the Fed was on hold.
Amid this construct of slow economic growth and relatively low interest rates, our long-term thesis of owning investments in companies with durable competitive advantages, balance sheet flexibility, and healthy free cash flow generation capabilities remains intact. Whether it be by market share gains internally generated or through industry attrition, we believe companies such as Apple Inc., United Healthcare, and Costco are industry leaders with strong digital capabilities that we believe will contribute to the transition to a new epoch in U.S. economic growth.