More than 5 years after the most acute phase of America’s financial crisis, the US unemployment rate is still far above its pre-crisis level. In a series of articles during the past few months, former Treasury Secretary Larry Summers suggested that the economy may be in a persistently depressed state (a “secular stagnation” in the technical jargon). The article sparked renewed debate among economists about whether such a prolonged slump was theoretically possible, and if so, whether the economy was in one right now.
An extended period of slow economic growth should be good for bonds (due to low inflation and interest rates) and bad for stocks and commodities (because of weak demand for goods, services, and raw materials). Yet there are reasons to think that even if the pessimistic side of the secular stagnation debate is correct, trying to adjust your portfolio in response could be a mistake.
One reason is that there’s only a very weak link between economic growth and stock market returns. A long period of low economic growth and high unemployment would hurt companies’ ability to grow their revenues, but it would also keep a lid on how much they have to pay their employees. The lack of pressure to raise employees’ wages is part of the reason corporate profits in the US have been so high since the financial crisis.
A second reason is that Summers and the other proponents of his hypothesis aren’t arguing that a prolonged slump is inevitable, but rather than the government would simply have to use some different policies to overcome it. They argue that policy changes such as increasing government spending on infrastructure, raising the central bank’s inflation target, and allowing more immigration would help boost investment in the economy and reduce the unemployment rate.
Shifting your portfolio to prepare for an extended period of weak economic growth therefore wouldn’t just be a bet that the pessimists are correct; it would also be a bet that the government wouldn’t properly adapt and that no unforeseen occurrences lead to a surge in investment. The secular stagnation idea was previously peddled by an economist named Alvin Hansen in the 1930’s, when he argued that trends such as a declining population growth rate would lead to persistent high unemployment. The unexpected baby boom following World War II invalidated his prediction.