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The economic news is truly exciting -- but if you're an investor, don't get too excited.
Okay, I know that a lot of people don't think "economic news" and "truly exciting" belong in the same sentence. But for us eco-wonks, the past few months have been absolutely remarkable. The much maligned U.S. economy has suddenly and spectacularly begun hitting on all cylinders. Being a rather odd engine, its number of cylinders is three: Output; productivity; and employment.
Output is the most important. It's what we mean when we say the economy has been growing, shrinking, stagnating, or anything else. For most of the past three years output has been growing slowly or actually shrinking, which is just a more precise way of saying the economy has been lousy. How lousy? The long-term historical annual growth rate in output is 3 percent to 3.5 percent. We managed to beat that in 2000 (3.8 percent), but then dropped into a recession for much of 2001, so the year averaged just 0.3 percent growth. Last year was better but not good: 2.4 percent.
And then, this year, the good times started to roll. Output rose at a 3.3 percent annual rate in the second quarter, which is entirely respectable, and then roared off the launch pad in the third quarter -- 8.1 percent. That rate is so high that it can't be sustained in an economy as big as ours, but who cares? It means the total value of everything we produce is once again rising fast, and that's good for everybody. While growth in output will surely slow down in coming months, it's clear we're back on the growth trajectory.
That fact is wonderful all by itself, but it gets even better when combined with the power of the second cylinder: productivity. That term is really shorthand for labor productivity, the value of what an hour of work produces, on average. Though it's obvious the productivity of the U.S. economy has on the whole been increasing forever, it by no means follows that a booming economy indicates rising productivity. From 1973 to 1995, for example, the U.S. economy mostly grew smartly. Even from 1973 to 1982, when the stock market went nowhere, output increased at a decent clip. Yet over the full 22-year period, productivity increased at the dismal rate of 1.4 percent a year, on average. (So why did output grow so nicely? Because we invested a lot of new capital, and because a whole lot of new people, especially women and immigrants, went to work.)
But now, in just the past couple of years, productivity has been leaping. Since the fourth quarter of 2001 it has been growing at a 5.1 percent annual rate, the fastest in 50 years. In the most recent quarter of this year it increased at the stunning rate of 8.1 percent. That info makes the terrific growth in output a bit easier to understand: Workers are producing much more. When each worker produces more, the nation gets richer.
In theory, rising productivity has a downside. When each worker produces more, companies may need fewer workers. That's why the powerful firing of the third cylinder, employment, is so impressive and so welcome. Rapidly rising productivity could cause unemployment to increase. Instead, just the opposite has been happening. Even as each worker produces more, on average, unemployment has been declining. It is now back below 6 percent -- which, let's remember, was once considered the minimum below which the U.S. unemployment rate could not descend.
Now put the pieces together. More people are working, each producing more, resulting in stunning growth of national output. And remember that just four or five months ago, the conventional view of the economy was near despondent.
That's what is so exciting: A turnaround this rapid and near-total is extremely rare.
So why shouldn't investors get too excited? Simply because they will be tempted to follow their classic, miserable pattern of chasing performance. The stock market has done what it often does so well: It predicted where the economy was going. All these wonderful economic statistics had yet to be released last summer, yet stocks jumped as the market discerned what was happening. Now, with the Dow in the neighborhood of 10,000, stocks look very fully priced.
They've had an excellent run in 2003, and all the strong economic news puts a glow around many companies. But that's all in the past, and the past counts for exactly nothing on Wall Street. The great question for investors is how much a vigorously improved economy will enhance the performance of companies beyond what is already priced into their shares.
Answer carefully. How you do so will determine whether your portfolio's performance will be, like the economy's, truly exciting.
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