Should We Really Be Afraid of Modest Economic Growth?

Economic Growth

Many people are concerned with how economic growth has evolved of late, with both GDP growth and inflation averaging around 2%, which some mistakenly think is too low.

2018 was a banner year of sorts as far as economic growth is concerned, with the 2.9% that we added being the highest rate since 2005, as well as the highest amount of growth during the 10- year bull move that the stock markets have enjoyed.

With things settling in around 2% for 2019-21, this at least gives us the perception that we are in a slowdown phase. Those who are looking for reasons to proclaim the end of the bull market are pointing their fingers at this number, and when you add in a distorted understanding of how stock markets work, this view may seem to have some credence.

We might think that growth slowing from the 2.9% that it came in last year at to our now being projected to have both growth and inflation right around 2% for the next 3 years may mean lower prices for stocks, even though it’s not clear at all where we get ideas like this.

It turns out that people just assume such things, starting with the assumption that stock prices move with economic growth or that this is even correlated enough to make such a claim, or at least think that this is more likely than not to be the case. If we simply look into this relationship, we clearly see that there is no such correlation and we really can’t tell very much at all by looking at GDP growth unless it turns negative.

What Really Pushes Stock Prices Higher

Stock prices go up from two things, which are the will of people to invest and the capacity to invest. Stocks do not ever change price by themselves, or from external factors such as company or economic data, they move because people put more money into them or take money out of them.

The investing of today is very much weighted toward stocks, and even investors who probably have no business taking on the extra risk that holding stocks over time involve, such as those of advanced age, still manage to invest in them a lot, and younger people are herded into the stock pen and are told to keep all or at least most of their investment money in them.

We’re also taught to stay the course, and this means just keeping on investing regardless of what is going on, in both good and bad times. We can call this the will to invest, and this will is generally strong, especially in bull markets and especially when we avoid negative GDP growth. This will is considerably stronger than in past times and this makes a big difference.

In other times, as our will wanes and especially if we feel like the market will be going down for a while, our will can become more tempered. When we look back upon past bear markets, the moves can be both large and sustained for very long periods, but it’s important to realize that the dynamics of investing has changed a lot over the last while, and at the very least, this makes these big bear moves likely to be more subdued.

We could describe this change as a result of stock investments being marketed much better than they were in yesteryear. There was a time where only the elite invested in stocks, but nowadays, a high percentage of people do, including just about everyone with a retirement account. We could even say that we are married to the stock market these days, and the ring is on the hand of the long side, which in itself presents a stronger bias toward upward stock prices than in the past.

Economic growth, and in particular, increases in income overall can increase our capacity to invest, and with more money to put in the stock market, we are prone to doing just that. If economic growth slows down, this affects our capacity to invest in a negative way, but not by enough to make much of a difference.

We see things like a dip in growth of 2 or 3 percent and stocks going way down. It is not the loss of growth or investing capacity that drives these moves down all that much, as the moves in stock prices can be 10 times this or more, and the other 90% or more must come from elsewhere.

It actually comes from a loss on the will side. The stock market dip in the fourth quarter of 2018 was an example of this, and we actually put up the highest GDP growth number of this decade long bull move last year, but it was the worst performing year for stocks during the period.

The Last 10 Years Have Only Provided Very Modest Growth

Over these 10 years, we have averaged 2.2%, right around where we are now, and this included some good years for the market where growth was only 1.6%. During the long bear market between 1968 and 1982, we averaged 2.3%, a little better, with stocks diving by two thirds. Between 1939-45, GDP growth averaged a whopping 13%, and the stock market declined during this time. This is just not a meaningful way to predict stock prices, although it doesn’t make sense that it would be.

If we’re concerned about the current level of growth, there is no reason at all to be afraid of numbers like 2.1%, 1.9%, or even the 1.6% that we saw twice already during this move. The important thing is that this stays positive, because when it goes negative, people get spooked and send stock prices down considerably.

Therefore, it’s not that GDP growth is a non-issue, but positive GDP growth is. There is simply no good reason to want to step in now and change things when they actually are as close to ideal as we could ever hope for, for both the stock market and the economy.

Slow and steady wins the race here, and that’s exactly what we have seen with our economy and the stock market both over the past 10 years. Things are even more stable now, and Fed’s ideal of 2% is not only being met, we’re doing this almost exactly now and expect to maintain this pace for a while.

There are some who criticize modern central bank monetary policy and feel that our economies are being over-stabilized and we’d be better off with the normal swings of boom and bust. Neither boom or bust is a good thing though, as booms bust, and it’s better to keep booming at a smaller but steady rate and do what we can to avoid the busts.

We have tamed the business cycle very well, and have also expanded stock investing very well, even though there is more that could be done to get people to invest more. As we realize more and more of this potential, as more people come to realize that their retirement needs to be saved and stocks are the ticket, this will add even more upward pressure to stock prices generally and make bull markets even more persistent and enduring.

A 1.9% GDP growth rate isn’t a bad hand to be sitting with right now, and it’s actually a very good one, not that this really makes much difference. A lot of people sure think so though, and plenty of people are on edge to some degree right now because of this. Maybe we don’t understand what is really going on here, but as long as stocks keep going up, we may be scratching our heads, but it’s done with a smile.

Andrew Liu


Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.