Productivity is The Most Important Number No One Is Talking About
Economists are divided over the reasons behind the slowdown in U.S. productivity growth, but its effects on future economic growth are unquestionably negative.
In the fourth quarter of last year, U.S. productivity, defined roughly as output per hours worked, fell 1.8%, as the labor force added workers faster than production increased output. While investors should not lose sleep over one bad number—productivity is a notoriously volatile indicator—unfortunately the negative reading was consistent with a longer-term weakening trend. For all of 2014 productivity was basically flat. Since exiting the recession in 2009 productivity has averaged about 1.30%, a full percentage point below its long-term average.
Should an environment of slower economic growth and modest gains in productivity continue in the U.S., what are the investment implications? First, corporate earnings growth is closely linked to real GDP, making performance of domestic companies more vulnerable. Second, because wages typically rise in-line with productivity over the long term, they probably will not pick up as much as the rebound in the labor market would imply without a faster acceleration in productivity (we are already experiencing this phenomenon). Lackluster wage growth means consumer spending, and ultimately earnings for consumer-oriented companies, will also grow at a slower pace. A slower pace of growth should not be construed as a disaster, but it is troubling for the long-term returns of a stock market that is already pricing in the best of all possible worlds.