Every year economists trot out optimistic forecasts of a global economic recovery and every year we're disappointed. HSBC's Stephen King thinks he knows why.
According to an ongoing Bloomberg survey of economists, expectations for 2015 U.S. gross domestic product growth have dropped from 3.2 per cent on Jan. 30, to the current 2.2 per cent. Mr. King, HSBC's chief economist, notes that "2015 is now likely to be the 13th year out of the last 16 in which the initial consensus forecast for economic growth will prove to be too high."
Optimists retain hopes that bad weather in the U.S. Northeast was the main cause of weak activity in the first half of the year, and that a sharp snap-back in the economy is imminent in the next six months.
One year the optimists will be right – but a look back at the past five years shows that 2015's mid-year growth disappointment is merely the continuation of a theme.
The chart below plots the annual course of the Citi economic surprise index for the United States. The index measures economic data relative to expectations. If, for example, industrial production statistics are reported above economists' estimates, the surprise index moves higher.
Note that 2010 is the only year since the financial crisis where the surprise index didn't make a steep early year slide indicating a long series of disappointing economic reports. In most years, the surprise index recovers in the latter half of the year but this isn't as positive as it seems. The index recovered primarily because economists had slashed their estimates for growth in the middle of the year – the line rises because the economic reports more often exceeded the lower forecasts.
Mr. King believes that the inaccuracy of economist forecasts is caused by a fundamental misreading of the low interest rate environment. In his assessment, economists have been expecting low interest rates to automatically translate into higher levels of corporate investment, hiring and consumer demand – only to be disappointed each year.
Mr. King writes: "it's worth reversing the causality. Instead of regarding low interest rates as a cause of stronger investment, it might make more sense to think of weak investment as a cause of lower interest rates… . Investors have become increasingly skeptical about the benefits of capital spending programs, [there's been] a major shift in the preference of savers in favour of a stable income stream… . One consequence is less risk-taking. Another, by implication, is lower investment and, hence, weaker economic growth."
In short, investor assets and corporate retained profits are being used to build and maintain income streams, not to invest in capacity expansion for the future. The share buyback mania is the most obvious example of the trend. Companies are using profits to repurchase shares, or using low interest rates to borrow the funds to accomplish the same thing. Buybacks support earnings per share growth – an equal amount of profit is split into a smaller number of shareholder pieces – to provide a steady stream of profits.
For HSBC, capital investment is the key indicator for the U.S. economy. Until corporate investment rises sharply, the U.S. economy – and by extension Canadian export growth – will remain sluggish.