Jim Paulsen on Inflation Threat, US Macro Outlook

Mon, Sep 27, 2021 - 11:19am

Recent economic data releases continue to fuel fears of a slowdown in economic growth heading into 2022, but don't get too pessimistic on the outlook for the United States, says Leuthold's Chief Investment Strategist Jim Paulsen.

Here's what he had to say in a recent interview on FS Insider (see Jim Paulsen: US Likely to See Higher Than Average Growth This Cycle for audio).

Slowdown...But to Higher Than Average Level

Despite continuing fears around COVID and its impact on growth, the US economy experienced a strong bounce back in activity with economic growth rates the strongest they’ve been in post-war history, he noted.

Even if we do see a slowdown — due to headwinds from fiscal and monetary policy wearing off, for example — the economy could very likely perform at an unusually strong growth rate compared to what we've seen over the past decade.

The main reason for this is due to a large list of structural tailwinds that aren't receiving a lot of attention right now, but will help into next year's slowdown.

“My expectation for next year is we do slow down, but I think it will hit 4.5 percent, which is … still among the upper echelon of growth rates that we've experienced since World War II,” Paulsen said.

Runaway Inflation Greatest Threat

Inflation is the primary concern, Paulsen noted. If it ends up running out of control, it will probably end the bull market and economic recovery.

However, Paulsen sees inflation that is more like what we experienced in the 1970s, in that it is more temporary. Inflation probably remained elevated longer than most thought it would, but he expects it to be temporary.

In addition, a slight slowdown from the extremely fast rates of growth earlier this year, should help to ease some of the inflationary pressures—especially those from supply chain bottlenecks where demand far exceeds current supplies.

If we see a moderation in the inflation data, there are several positive developments that are likely to help us maintain a higher rate of growth rate, leading Paulsen to anticipate growth closer to 4.5 percent.

“If we do that, that would be a huge increase from what we're used to,” Paulsen said. “It could make a dramatic difference in terms of earnings gains and the ability of the stock market to sustainably outperform people’s expectations, based on the idea that we're going to return to low growth.”

Structural Tailwinds

Paulsen listed a large number of factors during the interview that he believes will fuel growth going forward.

For one, pent-up demand has steadily risen since COVID hit, as consumers reduced durable goods purchases. We can expect to see consumers catch up over the next few years, which is likely to fuel growth.

New household formation in the US is also on the rise, at the fastest pace in post-war history, Paulsen noted, fueled my Millennials settling down as they enter their peak spending years. Decreases in mortgage rates have accelerated this trend, as well.

Counterintuitively, we’ve seen a surge in new business formations, which have hit record highs post-pandemic. Despite businesses closing, we’re seeing a net rise in new business formations.

In the face of supply chain bottlenecks, Paulsen expects to see a major inventory rebuilding in the United States as businesses seek to alleviate shortages and meet rising demand. The supply side of the economy is going to grow even faster than demand, which is going to add more to economic growth than it would if you didn't have an inventory rebuilding.

Sideline buying power is high, with a total personal savings of $3.5 trillion. If a quarter of this savings comes into the economy each year over the next four years, Paulsen expects this force alone should keep us near 4.5 percent growth.

Households are scoring on all their assets, borrowing is theoretically available, and the service-to-debt ratio is as low as it has ever been, Paulsen noted. Additionally, productivity is exceptionally high, and we still have 7.5 million fewer people working in the economy than when it last peaked, pointing to stronger productivity gains going forward.

All of these factors should contribute to substantially better growth and a continuation of the bull market.

“We’ve emerged with a lot of positive forces that not many are focused on, that go far beyond what policy officials are doing,” Paulsen said. “We'll be able to sustain a stronger growth rate than we've been used to in recent years. And that's why I'm probably more optimistic than most, because I think this recovery will last for a while, but it also could grow at a faster rate. If we can do that … that’s a pretty good environment overall for stocks.”

Paulsen offered substantially more insights in our recent interview with him on FS Insider. If you're not already a subscriber to our FS Insider podcast where we interview book authors, strategists and industry experts from across the globe 3 days/week on all things economics, finance and markets...

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Written by Ethan D. Mizer

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