Turning Points:

The Long and Short of It

May 2017

Lakshman Achuthan
Co-Founder & Chief Operations Officer

Turning points come in all shapes and sizes. To Shifting gears, and looking out a couple of
begin with, Ill focus on a few that are directly quarters, I then show that a fresh cyclical turning
related to the feelings of angst about todays point is already in clear sight.
economy.

First, there were two huge turning points in

the last couple centuries that form the backdrop
for whats happening today.

Moreover, in this century, weve been

experiencing a very different type of structural
shift that defines our growth potential in the
coming years.

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 Now, perspective is a funny thing.

This old cartoon of a New Yorkers view of

the world wildly exaggerates the importance
of the near at the expense of the far. You see
Manhattan in great detail in the foreground;
then New Jersey, the rest of America, and the
Pacific all scrunched up; and barely visible, Asia
on the far horizon.

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 GDP Share of Major Economies

Source: Wikipedia.org (Angus Maddison)

So it is with our sense of history. Because, again,

perspective is a funny thing.

From Angus Maddisons life work, we have

economic data going back over two thousand
years. Just like the distorted spatial perspective
in the cartoon, the way that data over time is
typically summarized also overemphasizes the
near at the expense of the distant past.

I took this chart from Maddisons Wikipedia

page. Please note that a thousand years on the
left of this chart occupies the same space as just
30 years on the right.

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 Share of World GDP (%), 1-2016 CE
100%

90%

80%

70%

60%

50%

40%
India
30%

20%

10% China

0%
1 101 201 301 401 501 601 701 801 901 1001 1101 1201 1301 1401 1501 1601 1701 1801 1901 2001

Instead, having updated the Maddison data and a thousand years later those percentages had
through last year, this chart shifts the historical only declined a little.
perspective to properly show the passage of
time. We still show the contributions to world But then, starting a couple centuries ago,
GDP from the major regions since year 1, but there were huge shifts with the rise of the West
the drama at the right-hand side of the chart is shown in blues which came to dominate
clearly epic. the global economy by the mid-20th century.
However, that historical moment was the
Before that, for more than 90% of these two exception in the long history of world GDP.
millennia, China and India dominated the world
economy in terms of real purchasing power. In With the benefit of this long view, its easy to
year 1, Indias share was nearly a third of global see just how breathtakingly fast the rise of the
GDP and Chinas was over a quarter both West was, and how equally swift the reversal of
bigger than the Roman Empire. Asia as a whole fortune has been.
produced almost three-quarters of global output,

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 Share of World GDP (%), 1820-2016
100%

90% U.S.
Canada, Australia,
New Zealand
80%
U.K.
70%
S.Africa
N.Africa France, Germany, Italy
60%
Other
W.Europe
50%
E.Europe
40% Former
USSR
India
30%
Latin
America
20%
W.Asia
Japan
China
10% Other Asia

0%
1820 1835 1850 1865 1880 1895 1910 1925 1940 1955 1970 1985 2000 2015

Zooming in on the last couple of centuries, So if youre a baby boomer, born at the that decline using the simple math behind
we see the details of this tremendous swing. height of the Wests dominance, youve been potential GDP growth that its the sum of
Europes Industrial Revolution, in combination witness to an epic reversal of fortune. And thats productivity growth and potential labor force
with Western colonial exploitation, was a key part of the angst that people are feeling. growth. To see what I mean, lets leave the
responsible for the collapse in Indias and centuries behind, and zoom in on the post-
Chinas shares of world GDP. The swift swing of the pendulum back from World War II period.
its mid-20th century extreme was triggered by
Asia, excluding the Middle East, plunged the end of colonialism, and in recent decades by
from an almost 60% GDP share in 1820 to only a great deal of technological catch-up in China
16% in 1950, which was when the Wests share and India, which isnt over.
stood at its zenith a record 57% of global GDP.
But also, U.S. trend growth has really
Asias resurgence started slowly, but soon downshifted for structural reasons in the 21st
accelerated, with its GDP share surging to a century. Before Lehman blew up in 2008,
160-year high in 2016. At the same time the Wests ECRI first identified the long-term decline
share has quickly fallen back to a 166-year low. in U.S. trend growth. We went on to explain

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 Growth in Labor Productivity and Potential Labor Force (%)
7

6
Labor Productivity
5

-1

-2
3
Potential Labor Force
2

-1
48 50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22
Shaded areas represent U.S. business cycle recessions.

This chart begins in 1948, and the blue line in the So, simply adding the CBOs potential
lower panel shows potential labor force growth, labor force growth of % to the latest five-year
which the Congressional Budget Office (CBO) average productivity growth of a little over %
projects will average about % per year for the equals about 1% longer-term real U.S. GDP
next five years (red horizontal line, lower panel). growth.
Given the demographics, thats pretty much set
in stone.

The green line in the upper panel shows

productivity growth, and for the past five years its
averaged a little over % per year (red horizontal
line, upper panel). Thats far below its pre-crisis
average of 2% per year (gold horizontal line,
upper panel). Its not that its impossible for
productivity growth to rise at some point, but its
unlikely to do so anytime soon.

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 G7 Labor Productivity and Labor Force, Growth Rates (%)
5.0
5% 6% 7%
4.5
4% Japan
4.0

3.5 Germany France

3%
3.0 Italy

2.5 U.K.
Labor Productivity

2%
2.0 U.S.
X Canada
1.5
1%
1.0

0.5
0%
0.0
-0.5 0.0 0.5 1.0 1.5 2.0 2.5

Potential Labor Force

And this structural downshift in trend growth The starting coordinate for each country is The red X shows Japans lost decades
shown by this simple math goes well beyond the 1957-2007 average for productivity growth and from the early 1990s to the eve of the financial
the U.S. labor force growth. In that period, potential GDP crisis. The G7 economies are heading for even
growth for the U.S., for example, was above 3%. worse predicaments.
This chart summarizes the same kind of
simple math for all the G7 economies, with The ending coordinate near the arrow head Most arent explicitly aware of all this, but
productivity growth on the vertical axis, and marks the average productivity growth for the many look to emerging markets for a more
potential labor force growth on the horizontal past five years, and potential labor force growth positive structural growth story.
axis. Seeing them together is quite revealing. for the next five years. These statistics take the
U.S. down to about 1% potential GDP growth.
The slanting gray lines are what we call iso-
GDP growth lines, and they capture the simple Taking in the whole chart, its clear that
math. So, at every point on the slanting 1% every G7 economy is headed in the wrong
potential GDP line, the sum of labor force and direction, converging toward 0-1% trend GDP
productivity growth equals 1%. growth, marked off by the two slanted gray lines
labeled 0% and 1%.

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 BRIC Labor Productivity and Labor Force, Growth Rates (%)
10
9% 10% 11% 12%
9 China
8%
8
7%
7
6%
6
5%
GDP/Person Employed

5
4% India
4
3%
3
2%
2
1% X
1 Brazil
0% Russia
0
-1%
-1
-1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5

Potential Labor Force

But a simple math chart for the BRIC in productivity growth. So its potential GDP dont change from year to year. Taken together,
economies shows a mixed bag. Again, the red X growth is slipping to zero. its clear that the worlds growth potential has
marks off Japans lost decades as a reference point. downshifted.
China and India are completely different,
The same productivity data is not available, yet even China is losing altitude, from over 10% Now we turn to cyclical issues that
so we substitute growth in GDP per person to about 7% trend GDP growth, as potential absolutely do shift direction in the short term.
employed as a proxy. The starting coordinate for labor force growth falls to zero, and productivity Lets look at some of the most interesting ECRI
each country is the 1991-2007 average. growth slackens. In contrast, trend GDP growth leading index charts.
for India is actually headed up towards 7%, as
Brazils potential GDP growth, which India has the best demographics of the lot, and
used to be around 3%, is headed below 1%, as its productivity growth is improving.
both potential labor force and productivity
growth suffer. So, for both the G7 and the BRICs, these
structural bounds define the growth potential
Russia is much worse off, thanks to dismal for the next several years in other words,
demographics, despite a slight improvement underlying patterns in economic growth that

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 U.S. Long Leading and Coincident Indexes, Growth Rates (%)
8

USLLI 4

0
4

3
USCI

1
Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17

As you might know, ECRIs co-founder, the late USLLI growth is designed to peak and This outlook is important to investors
Geoffrey H. Moore, created the first leading trough before USCI growth, which is the best looking at the overall cyclical picture. But
index half a century ago, which is why The Wall summary measure of the economy outside our for those more focused on certain sectors, or
Street Journal called him the father of leading windows including broad measures of output, stocks, we turn to our sector-related leading
indicators. employment, income and sales. indexes.

Since then weve developed over a hundred The USCI shows that a growth rate cycle
indexes for a couple dozen countries, including (GRC) upturn started in mid-2016, and that
long leading indexes that look further ahead upturn was anticipated by the earlier upturn in
than typical leading indicators like stock prices USLLI growth.
or PMIs.
With USLLI growth still rising, the upturn
This chart shows the U.S. Long Leading in USCI growth will continue. And theres no
Index (USLLI) and U.S. Coincident Index recession in sight this year.
(USCI) growth rates.

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 U.S. Leading Services Index, Growth Rate (%)
4.2

4.0

3.8

3.6

3.4

3.2

3.0

2.8

2.6

2.4
May-14 Aug-14 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Feb-17 May-17

The U.S. is largely a services-based economy, so

we monitor cycles in financial services, non-
financial services, and the overall service sector.

Here we see overall U.S. Leading Services

Index growth, which has been in a clear cyclical
upturn since last year, and continues to point to
stronger growth ahead.

This is a key part of the ongoing GRC

upturn for the overall economy.

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 U.S. Leading Construction Index, Growth Rate (%)
8

-2
May-14 Aug-14 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Feb-17 May-17

This chart shows U.S. Leading Construction

Index growth, which has been improving since
last year, and points to continued growth in the
coming months.

So another key sector is supporting the

overall economic growth recovery.

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 U.S. Leading Manufacturing Index, Growth Rate (%)
20

16

12

-4

-8

-12
May-14 Aug-14 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Feb-17 May-17

But, according to our forward looking data, Ill come back to this looming manufacturing
there is one problem sector: manufacturing. slowdown in a moment, but lets take a quick
look abroad at something weve been tracking
This chart shows U.S. Leading Manufacturing since last year.
Index growth, which clearly anticipated the
ongoing cyclical recovery from the earlier
manufacturing recession. But its easy to see that
it has started to hook down, and that points to a
new downturn in U.S. industrial growth.

So, to recap the U.S. cyclical outlook:

Long Leading Index: good
Leading Services Index: good
Leading Construction Index: good
Leading Manufacturing Index:
slowdown at hand

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 EM-DM Long Leading Index Growth Differential (%)
7

-1

-2
Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17

Remember the U.S. Long Leading Index from a Today, everyone knows that emerging
moment ago? ECRI also maintains similar long markets have been the hot asset class of 2017.
leading indexes for over 20 economies, including But as you can see, this measure moved up more
all the major emerging markets. than a year ago, and following the election when
emerging markets were not in favor, it again gave
A key characteristic of our long leading the correct, contrarian message.
indexes is that they are truly comparable across
borders, which makes it possible to track their In other words, while weve been optimistic
relative performance. about the U.S. cyclical outlook, weve been even
more optimistic about EM.
That is what this chart shows the
difference in the growth rates of our long But, as with any cycle, the question is, how
leading indexes for emerging markets (EM) and much longer can it go? While we dont predict
developed markets (DM). As the line moves up, the predictors, weve been tracking a different
EM prospects become relatively better than DM warning signal from our farthest-seeing leading
prospects. index that has us concerned.

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 Indicators of Global Industrial Growth
0.9
Global Industrial Growth Long Leading Index 0.8
0.7
0.6
0.5
0.4
0.3
0.2
25
20
Global Leading Manufacturing Index Growth (%)
15
10
5
0
4

3
Global Industrial Production Index Growth (%)
2

0
Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17

This slide relates to the global industrial growth Following that downturn, growth in the think everythings fine. But for those who track
cycle, and this cycle impacts the U.S. too. At shorter-leading Global Leading Manufacturing commodity prices, some might be starting to
the bottom of the chart we show actual global Index the middle line has also turned down. get antsy.
industrial growth. Its had a decent recovery last That sequence, first the long leading index and
year off its lows, flattening a little recently. then the short leading index turning down, adds
conviction to this call.
Most people expect the recovery to
continue. We dont, and heres why. Remember the earlier chart of U.S. Leading
Manufacturing Index growth turning down. The
The Global Industrial Growth Long Leading U.S. manufacturing slowdown will happen in the
Index, shown at the top, is the farthest-seeing of context of this nascent global industrial growth
all our leading indexes. It leads cycles in global downturn.
industrial growth the industrial sector of the
global economy shown by the blue line by Again, if you were only looking at industrial
almost a year, and it has turned down decisively. growth shown by the blue line, you may still

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 JoC-ECRI Industrial Price Index, Growth Rate (%)
50

40

30

20
Exchange-Traded
Non-Exchange-Traded
10

-10

-20

-30

-40
11 12 13 14 15 16 17

This chart shows growth in the Journal of down lately. This is how the cycles in global And while the cyclical outlook hasnt
Commerce-ECRI Industrial Price Index, which industrial growth show up in commodity price been this good in years, theres a fresh
weve been running real-time, daily, for over inflation the strong run up last year and then global industrial growth downturn on
three decades. the about-face this year. And the global industrial our doorstep.
growth leading indexes from the previous slide
Half of its components are exchange traded provide a strong indication that this isnt over.
(the red line), but the other half are not (the
green line), allowing us to see through some of To wrap up, so we can take some questions:
the speculative market forces. Fun fact: In his Over millennia, Western economic
maestro days, Alan Greenspan watched a key dominance was the exception, not
part of this index every morning. the rule.
In recent years, structural constraints
Toward the right side of the chart you see have been pushing down potential growth
that the growth rates of the exchange-traded and globally, and they remain in force.
non exchange-traded components both turned

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