The economy and the markets have surprised most observers and analysts alike. Despite the historic hike in interest rates that began over two years ago, the economy has yet to enter an official recession as most had expected, including me. The residual cash left over from the pandemic relief packages from Congress and the monetary stimulus from the Federal Reserve still linger in the economy to power it through the anticipated recessionary period. Along with the excess cash, inflation has also lingered longer. While the inflation rate has come down, higher prices have not. In other words, the dramatic price increase of almost everything has stabilized at higher prices but have not retreated to pre-pandemic levels. This new and potentially permanent higher price floor explains the discouragement among American workers about the future, despite a generally strong labor market.
The latest “jobs report” from the Department of Labor released last week was nothing short of astonishing. The anticipated increase in new jobs to be created was 200,000. The actual number was 303,000, 50% higher than expected. The unemployment rate slid to a historically low rate of 3.8%. Finally, wages increased by 4.1% year-over-year, a three-year low but finally outpacing general inflation. Altogether, the report revealed a very strong labor market. Further supporting the strength of the economy is the latest Gross Domestic Product (GDP) figures, which showed an expansion of 5.86% in 2023, even though interest rates remained restrictive.
Most economists and market analysts have expected interest rates to steadily decline this year as the economy slowed down. The expectation at the beginning of the year was that the Federal Reserve would begin to cut rates by 0.25% six times this year for a total of 1.50%. That expectation was reduced to only three quarter-point cuts. Now, considering the current “Jobs” report, there is little reason for the Federal Reserve to lower rates at all. There is some evidence that the labor market could be weakening, and there is a pattern of revising lower in future months some of the “Jobs” and GDP reports, but for now, the two reports corroborate strength. It is this strength that has the market trading in a range at or near all-time record highs. It is likely that corporate earnings will continue to perform well as the consumer continues to spend.
It seems to me that we are at the early stages of a significant transition in the economy, that is likely to be missed by traditional economic analysis. The transition is taking place at multiple levels in the economy and in many facets of the economy. First, the two economic indicators cited above – the “Jobs” report and GDP – look at the economy from a macro level. What those indicators might miss is how small businesses are affected. According to the National Federation of Institute Business (NFIB), small business optimism is at an 11-year low, despite the overall strength of the economy. Inflation, especially wage inflation, has hit small businesses very hard. Small businesses, for the most part, don’t have the pricing power of big national companies, like Amazon, Walmart, Costco, Home Depot and national restaurant chains. Large companies benefited greatly from the economic disruption of the pandemic, while small businesses struggled to survive. A quick glance at strip shopping centers where small business retailers usually reside are increasingly vacant.
The second factor in the transition economy is Artificial Intelligence (AI). While AI and machine learning have been around for a while, only in the last year has AI been readily available for widespread use. Tools like ChatGPT, Microsoft’s CoPilot and Salesforce’s Einstein are now available to all businesses. The race is on to implement and deploy AI throughout all enterprises. AI will not replace the human brain, it will, however, make every worker exponentially more effective and productive. The next few years will likely be a time of shifting, those enterprises that embrace AI will likely thrive, and those who don’t will wither. This will be an especially big challenge for small businesses who might be slow to move in this direction. AI represents a path forward for big and small businesses alike, essentially to make today’s higher-paid worker more effective and productive.
The third factor to be aware of is the demographic shifts that are taking place in the U.S.. A large segment of the workforce is approaching retirement age. When these workers retire there will be gaps that businesses will have fill, but there are few workers to step into the gap. America, like several other industrialized countries, has a population imbalance, due to smaller and delayed family formation. Consequently, there is a talent and labor shortage across the business spectrum. Nearly all new jobs created in the U.S. are now being filled by foreign born workers. This is particularly pronounced in the last four years. The foreign worker designation is applied to both legal as well as illegal workers. Viewed another potentially more alarming way, in the U.S. currently, very high-skill & very low-skill positions are predominantly filled by foreigners. According to most polls, immigration is the most important political issue in the upcoming election. It may well be the most important economic issue in the years to come.
Summary
The economy and the markets, as always, are in a constant state of flux. The stock market quickly reflects where the economy is headed. It seems to be telling us that the next six to nine months are going to be good and stable. The longer-term issues, as always, are more difficult to discern. The uneven economic environment is more difficult for small businesses to tread. AI is already a key disruptor and will continue to be in the future. And then finally people, from the aging worker to the newly arrived worker will be a decisive factor in the years to come. The best approach to an uncertain future is to save, defer into your 401(k) account and to measure your risk exposure carefully.
