The US Economy Is at a Turning Point—and the Stakes Are Higher Than You Might Think

Vanguard’s chief economist breaks down whether AI can outpace the drag of aging and deficits, and why investors should prepare for a future that’s anything but the status quo.

Joe Davis: How to Capitalize on ‘Megatrends’

Why the Status Quo for the US Economy Is Unlikely to Persist

Dan Lefkovitz: So, there’s this fundamental premise in the book, Joe, that the status quo for the US economy is unlikely to persist—status quo regarding growth, inflation, financial returns, even. Why is that?

Joe Davis: And this was a surprise, the eye-opener for me. In full disclosure, I’m asking my role at Vanguard, chief economist, I felt these what’s called consensus surveys. What’s the outlook for growth, GDP, or inflation, where the stock market for the next three, five, seven years? And for GDP growth and inflation, I put down what most put down, which is 2% growth and 2% inflation. I wasn’t being lazy. Maybe there’s comfort because everyone else says the same thing. Virtually 90% of the economists say the same thing. And I’ve been in that crowd because it was kind of like, I’m probably indirectly, I was doing in my head in a more narrative sense, well, we’ll have a little bit of lift from AI, a little bit, but we’re going to have slower demographics through the aging of the baby boom. And so, net-net, we’re going to be roughly at the same growth rates and inflation 2%; 2% as we have on average for the past 10 or 15. Hence status quo, no real change.

It was only when we developed this data-driven framework did I see that that was just a lower-probability event. Effectively, we have trouble generating that as greater likelihood than 20%. Because of the push and pull of these medium-run forces, and in particular, the push down on growth and up on inflation and interest rates from our deficits, because they’re structural and they compound over time versus on the other hand, AI—I’m calling it AI, although it could be another technology, but AI is probably the most likely one—AI pushes up growth and keeps inflation at bay. And what I was surprised to find is the push and pull of those dynamics over the next three or five years generates effectively statistically a bimodal outcome, which is not the normal sort of status quo distribution where you get 2% on growth and inflation with the risk of a little black swan on either side. It’s just very unlikely we’re going to get that sort of fulcrum. It’s more of a seesaw. And one of those forces is going to push us one way or the other.

Will AI Be Able to Win the Tug of War Against Aging and Rising Deficits?

Christine Benz: So, let’s follow up on that, Joe, because in the book you talk about two possible outcomes from that tug of war. Can you walk us through that? So, this is a tug of war between technological innovation, probably AI, and an aging population and rising deficits.

Davis: So again, we’re incorporating a lot of forces that could matter—geopolitical risk and uncertainty, even climate. But you nailed it on the head, Christine, in terms of the two that rise to the top: aging and deficits on the one side, which push up interest rates and the prospect for technological change, much like we saw in the 1990s, if you recall, and the computer and the internet on the other side. We don’t always get these sort of seesaw dynamics because we’ve tested this framework back 130 years. It’s just there’s times in history when these megatrends are pushing in certain directions.

So, let’s break it [down], each one. The more optimistic one is the most likely. And I think what’s powerful is from a risk management perspective, we’ve put odds and quantified the probabilities and magnitudes of this. So, it’s roughly a 50% chance that over the next five to seven years, we will see GDP growth that’s meaningfully above the consensus expectations, so roughly over 3% for the United States, well above consensus expectations, roughly double them. And we get that with our deficits not being a serious issue. It doesn’t mean we’ve grown out of them. It doesn’t mean that they’ve gone away. But like the late 1990s, we don’t talk about it because we have strong earnings growth and economic growth. And we get that along two dimensions of AI.

The first one is it starts to lift automation. Yes, there’s significant job disruption, some job loss. But the fact is, is that through our framework, the biggest issue with the US economic growth is that we have a lack of automation. It’s subtracting the most from economic growth in 130 years. And we know this because of our framework incorporating all these factors. It effectively comes at the right time. It effectively means—and I didn’t know this until we quantified it, Christine—it effectively means that the rest of the baby boom that is retiring right now—we’re in peak age, 65, right now in the United States. The number of people who are age 65 is peak in the year 2025—it’s effectively that that generation from here on through, say the year 2032, it’s as if all of those Americans, those individuals do not retire at all because of the lift that AI comes to offset some of that loss in the labor force.

So, demographics don’t become destiny because of technology—and we’ve seen this multiple times before—that is a very positive dynamic. In effect, we grow into the valuations that we have in the United States. And from a positive investment perspective, the greatest beneficiaries are outside of the US technology sector. It’s in the US; it’s the areas that have really dragged. It’s outside of effectively the Mag 7, because AI makes a value-based company, say healthcare or finance, a little bit more productive. And then you get some new products. I wish I knew what they were because I’d be able to retire from Vanguard, but I really don’t know what they are.

And it lists a little bit of the valuation. You go back to your fair question, Christine, on outside the US. We’ve seen this in other second halves of other technology cycles. The non-US sectors do a little bit better. So, I would call that a good convergence, and AI wins, and deficits don’t really rear their head, at least over the next seven to 10 years. However, you can see where a lot rests on AI. AI is important. It will have some effect. It’s already having a modest effect on growth. But if it does not continue to progress, which means advancing its capabilities, and our projections show that more often than not, they do. But there’s a one-in-three chance because we’re still early here, that it plateaus at a lower plane. And if that happens, you can see now where we have not gotten the lift through automation, new products through, let’s call it AI. We have GDP now through no lift in innovation. We now have demographics dominating. We have GDP growth not at 2%. Now it’s starting to inch closer to 1%. Our deficits, however, still now are 8% or 9% of debt to GDP in peacetime, so without a recession. That starts to push up inflation expectations in our framework. The Federal Reserve, however, fights that, which only leads to another modest headwind to growth. So, you get a higher interest rate environment without the growth dividend with it. And you have equity markets that are not prepared for that. Earnings are starting to disappoint because you have lower economic growth. And you can see the flywheel goes from positive to modestly negative. And in the US, given where valuations are—I hate to be a downer—but you have an elevated risk of a lost decade in the US stock market.

So, you can see the stakes are high between this tug of war. And this was the eye-opener to me. It’s over the next seven or 10 years, that’s why I felt compelled to help investors, because as an economist, I can’t say, “Hey, there’s two doors we go down. There’s a good one and there’s a not-so-good one. Good luck to you with investing.” So, we try to push ourselves to say from a risk management perspective, how can I think about a portfolio that’s kind of resilient to both scenarios?

Jess Bebel (Αναδημοσίευση από www.morningstar.com)