We are looking forward to 2014 with optimism, and we believe the key factor supporting the U.S. and global economies in the present phase of the economic cycle will be productivity growth. Our comments below were prompted by a similar analysis recently published by John Hook of Hook Analytics.
Gross domestic product (GDP) is the market value of all goods and services produced in an economy. This is a nominal value -- it must be corrected for inflation to give us “real” GDP. It’s the real growth of GDP that we are interested in as investors. While there are always sectoral and company-level growth differences, it is the outlook for real GDP growth that will give us a “rising tide” or a “falling tide”… and gives us a view of the current economic environment.
We believe this view is of critical importance for investors. Many investors waited out some or all of 2013 on the sidelines and failed to benefit from the market’s gains. Although we don’t expect a ride without bumps in 2014 -- a correction of 10 percent or more wouldn’t surprise us -- we believe that when the year ends, the U.S. market should be higher by about 10 percent. As the year progresses, the awareness that the economy is show- ing accelerating growth will ease some of the lingering fears that remain from the Great Recession.
Components of Real Growth
Real GDP growth has two components: population growth, and productivity growth. Population growth by itself will raise GDP, simply because there are more people working, producing, and earning -- and demanding goods and services.
However, there are two factors that make population growth insufficient as a driver for growth -- and as a driver of corporate profits. First, population growth is basically in a state of decline. It has been observed around the world over the past two generations in particular that worldwide population has grown at a slower pace as the total world population has risen.
It is becoming apparent to demographers that economic development leads to a gradually falling population growth rate. In some highly-developed European countries (as well as in Japan), the population growth rate has even turned negative -- meaning that in the absence of immigration, their population would actually be shrink- ing. And second, population growth, even where it is positive, is simply not very robust -- not robust enough to sustain the returns for which investors are looking.
Productivity Growth: The Holy Grail
Since population growth is a small component of real GDP growth, the overwhelmingly important factor for investors to consider is productivity growth -- that is, growth that comes not just from an increase in the number of workers and consumers, but that comes from an increase in how much each worker is able to produce.
The graph below shows the cost of a three-pound chicken expressed in terms of hours worked by an average non-supervisory worker in the U.S. -- that is, how long would someone have to work to purchase that chicken? The steady improvement over the past cen- tury came from productivity growth. Productivity growth makes goods and services more abundant and accessible to consumers -- and drives corporate profits for the firms that produce them.
Key Factors in Productivity Growth
Productivity growth rates rise and fall in cycles, just as overall economic activity does. We believe that the present phase of the economic cycle favors rising productivity growth, and we will be attentive to the factors that support it -- or work against it. We believe that attentiveness is necessary to enable investors to correctly identify the stage of the economic and stock market cycle.
The first major component of productivity growth is technological innovation. Technological innovation has of course been a key growth driver during all of human history -- but it became critically important during the initial phases of the industrial revolution. This was particularly due to technologies allowing manufacturers to exploit new energy sources.
Those two factors -- the application of technological innovation to the provision of goods and services, and the discovery and refinement of new energy sources -- are key elements of the productivity growth acceleration we believe is getting underway in the U.S.
Computers and the New Industrial Revolution: Big Data, Robotics, and AI
The revolution in computer technology is ongoing, and has been since the 1970s, but it is far from exhausted. One recent sub-revolution, the internet, is now about 20 years old, but more recent aspects of the computer revolution -- such as big data analytics, robotics, and artificial intelligence -- are really just beginning. (This is why the advent of computing has been heralded by some analysts as a “third industrial revolution” after the initial industrial phases of the 19th and 20th centuries.)
Besides the cutting edges of the revolution in robotics and AI, we also note the tremendous significance of the shale energy boom. We have made many observations in our letters letter about the astounding effects of new technologies for exploiting shale oil and gas reserves. Even just in the past year, we have seen refinements of shale drilling techniques which promise to bring the U.S. closer to energy independence -- earlier than the most optimistic estimates from the beginning of the shale revolution.
Energy played a crucial role in the long term productivity growth of the world economy, and the ongoing shale revolution in the U.S. promises to give the U.S. economy a significant edge in the coming years. We anticipate that technological revolution in this sector is far from finished -- and that further improvements will result in still further acceleration of reserve and production growth.
Of course these two sectors are far from the only sectors where ongoing technological revolutions promise ac- celerating productivity growth. Two additional sectors where we have seen extraordinary technological changes are biotechnology and materials science -- and we expect that more productivity-enhancing innovations are in store.
So Why the Anemic Recovery?
With these extremely bullish technological factors in place, the question remains why the recovery from the Great Recession has seen historically low productivity growth.