Global Macro Strategy

A weekly analysis of timely economic strategy issues from Wells Fargo Investment Institute.

September 27, 2016

Ken Johnson, CFA, Global Research Analyst
Paul Christopher, CFA, Head Global Market Strategist

A Look at U.S. Economic Growth

  • The labor and housing markets have been two of the brightest spots for the U.S. economy.
  • We see signs that the depressed level of business capital investments has reached its bottom and foresee improvements from here.

What it may mean for investors

  • Although headwinds continue for the U.S. economy, we continue to favor growth prospects for the U.S. economy over those for international developed and emerging economies.

The final revision for second-quarter U.S. gross domestic product (GDP) growth will be reported this week. In anticipation of that report, we are revisiting the state of the U.S. economy. The most recent release showed that real second-quarter GDP grew at an annual rate of 1.1 percent vs. the original estimate of 0.8 percent. We believe that U.S. economic growth has been held back by lackluster corporate profits, low productivity, weak business capital spending, and uncertainty over the election and Federal Reserve (Fed) monetary policy. Despite these challenges, GDP has grown due to strong domestic consumer spending and an improving housing market.

U.S. corporate profits (following adjustments for inventory valuation and capital consumption) renewed their decline last quarter—falling $24.1 billion after a $66.0 billion increase in the first quarter. This profit decline largely resulted from global economic weakness and the strong U.S. dollar. Yet there are several developments that could help to reverse these challenges. Nations around the globe have implemented stimulus programs to boost economic growth, and these efforts are beginning to bear fruit in the Eurozone and other regions. This could increase demand for goods (and services) produced by U.S. companies. Further, U.S. dollar appreciation recently has moderated. (Yet, once the Fed begins to raise rates, we could see some further dollar strengthening.)

Corporate profits help to drive private-sector spending on capital and labor. The deterioration in earnings has significant implications for nonresidential investments, which account for roughly 12.4 percent of U.S. GDP. Since 2015, nonresidential investments have declined, in part because companies have been reluctant to make expensive capital purchases when there is uncertainty surrounding the economy and future profit levels.

This weakness in nonresidential investments has implications for domestic productivity, which is a key driver of GDP growth. Productivity measures how efficiently workers use technology and machines, and how efficiently machines use raw materials. According to the U.S. Bureau of Labor Statistics, U.S. productivity growth has averaged only 0.5 percent between 2011 and 2015. This is a steep drop from the last decade when productivity growth averaged 2.6 percent. Although firms continue to add workers, they are not adding tools (such as technology and machines) at a matching pace. Even if business spending on structures and equipment turns to growth from contraction, we do not look for a rapid increase. When workers have outdated or insufficient tools, their efficiency is lower, so profits and wages may fail to accelerate. This missing link likely will remain a significant headwind for the U.S. economy in the coming year.

The Fed remains at a standstill. Last week, the Fed decided to hold off on raising rates largely due to soft fixed nonresidential investments and persistently low inflation. The market expectation for a Fed rate increase in December stood at 51 percent this week.1 An increase in U.S. rates could make investing domestically more attractive than investing abroad. We could see modest currency appreciation against currencies in Europe and Asia once the Fed decides to move rates higher.

Chart 1. Atlanta Wage Tracker Chart 1. Atlanta Wage TrackerSource: Bloomberg, 9/26/16.

Despite slow profit growth, the U.S. labor market generally continues to strengthen. More than 151,000 jobs were added to nonfarm payrolls in August after 275,000 jobs were added in July. The employment rate remained flat at 4.9 percent. Yet Chart 1 shows that year-over-year wage growth remains muted as wages grew at a modest 3.3 percent in August vs. 3.4 percent in July (according to the Atlanta Fed Wage Growth Tracker). The recovery in this wage index since 2014 reflects improved hiring, but these wage gains are likely to reverse as new workers enter the workforce. As mentioned above, a more sustained increase in wages awaits faster productivity growth.2

Headwinds exist within the U.S. economy for all the reasons that we have discussed. Yet we continue to favor growth prospects for the U.S. economy over those for international developed and emerging economies today.

As Chart 2 illustrates, emerging markets have struggled with deteriorating corporate earnings. There are other fundamental challenges as well. We expect commodity-producing countries in the emerging markets to face ongoing growth challenges as commodity prices settle into their wide ranges. Additionally, the world’s largest emerging economy, China, continues to grow at a slow pace as the country implements reforms and transitions to a consumer and service-based economy from a manufacturing and export-driven one. Slower growth in China could have spillover effects to other emerging economies. Finally, as the Fed moves forward with its plans to normalize interest rates, asset flows to the emerging markets could be impacted.

Chart 2. MSCI Emerging Markets Index Earnings Per Share (Year- Over-Year Percent Change)Chart 2. MSCI Emerging Markets Index Earnings Per Share (Year- Over-Year Percent Change)Source: Bloomberg, 9/26/16. Past performance is no guarantee of future results.

Developed economies abroad, particularly the Eurozone and Japan, face their own threats to growth. Weakening business and consumer sentiment remains a significant concern for the Eurozone, while Japan has struggled with implementing effective monetary policies to escape its current deflationary trap. The newly-announced stimulus package released by policy makers at the Bank of Japan has provided more clarity to financial markets, but long-term success of these policies remains unclear at this time.


Ongoing challenges for economic growth abroad keep our investment focus more heavily weighted toward the U.S. economy. Fortunately, we believe that the U.S. economy will improve gradually after the slowdown of the past four quarters. The final release of second-quarter GDP data later this week may show a slight increase over the growth data in the previous release. Looking ahead, despite the sluggish improvement in productivity, the labor market has been one of the bright spots for the U.S. economy, and we don’t foresee a shift as we approach year-end. The recent rise in wages should support inflation’s slow recovery toward a rate that is closer to the Fed’s target of 2.0 percent. A healthy inflation level should increase the value of consumer and business spending, which may help to trigger more production. In conjunction with the strong labor market and our forecast of higher inflation, we anticipate a moderate increase in U.S. real GDP over the next 12 months.

1 Based on fed funds futures market data from Bloomberg, September 26, 2016.
2 This index takes into account the composition bias that is inherit in the average hourly earnings data that is provided by the Bureau of Labor Statistics. The latter includes the large number of older workers who soon will be leaving the workforce and whose steady high wages suppress overall wage growth for new entrants and others in the workforce.

Risk Factors

All investing involves risks including the possible loss of principal. Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers. Investments in equity securities are generally more volatile than other types of securities.

There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained.

Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.


An index is unmanaged and not available for direct investment.

MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 23 emerging market country indexes: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.

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The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained. Any market prices are only indications of market values and are subject to change.

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