Sample Research Paper on U.S Economy

U.S Economy

While the U.S economy has over the years been faced with major financial crises, it has nonetheless, remained strong against other leading global economies. The 2008 recession was severe and according to several economic indicators, it was more severe than the 1930’s depression (Elwell 1). While the U.S economy took a beating form the 2008 financial crisis, it has been on a recovery path in recent years. The U.S economy remains to be the most productive, competitive and influential economy in the world attracting many foreign investors annually.

There is ample evidence in literature to back the claim that the U.S economy is on a path to recovery. According to the Bureau of Economic Analysis, the real gross domestic product (GDP) increased by 2.2 percent in the last quarter of 2014. In the third quarter of 2014, there was a 5 percent rise in real GDP. Real GDP is a measure of the production output of services and goods in any one country. At the same time, there was a 4.4 percent rise in real GDP of the U.S economy in the fourth quarter of 2014, up from a 3.2 percentage increase recorded in the third quarter (Bureau of Economic Analysis par 6). The Bureau of Economic Statistics notes that some fourth quarter of 2014 included an increase in business investments, and more so in the intellectual property products, as well as an increase in the export of goods and services, especially in food and beverages.

Compared to the previous quarters, imports of goods and services offset growth by increasing, notably in consumer goods. Moreover, the growth in real GDP was also offset by the federal government’s spending on national defence. In the fourth quarter, corporate profits reduced by 1.4 percent following a 3.1 rise in the third quarter. In the whole of 2014, there was recorded a 0.8 percent drop in corporate profits following a 4.2 percent rise of the same in 2013 (Bureau of Economic Analysis par 6). Despite this decrease in corporate profits, an increase in consumer spending was a positive indicator of the rise in the purchasing power of consumers in the U.S, which is often due to a rise in per capita income owing to better living standards.

The employment situation recorded a favourable change in the month of February, 2015. According to the Bureau of Labour Statistics, unemployment rate declined to 5.5 percent. This was attributed to a rise in non-farm payroll employment by 295,000 people. The gains in jobs were recorded in the hospitality industry, construction, transportation, warehousing, health care and professional and business services (U.S Department of Commerce para. 5). However, there was a decline in jobs in the mining sector. Over the past year, there has been a steady reduction in the rate of employment. Statistics available from the Bureau of labour reveal that employment in the past one year has decreased by 1.2 percent which represents 1.7 million people.

According to the US inflation calculator (as published by the Bureau of Labour Statistics), inflation in the U.S was 0.0 percent through the month of February. Inflation rates are an indication of the relative general prices level of goods and services. When an inflation rate increases, it reveals that the prices of goods and services are rising and therefore reducing the purchasing power of consumers (U.S Department of Commerce para. 6). Inflation rates have been improving since the financial crisis with the year 2008 recording the highest rate as illustrated below.

 

Table of Inflation Rates by Month and Year – (2008-2015)

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Ave
2015 -0.1 0.0                      
2014 1.6 1.1 1.5 2.0 2.1 2.1 2.0 1.7 1.7 1.7 1.3 0.8 1.6
2013 1.6 2.0 1.5 1.1 1.4 1.8 2.0 1.5 1.2 1.0 1.2 1.5 1.5
2012 2.9 2.9 2.7 2.3 1.7 1.7 1.4 1.7 2.0 2.2 1.8 1.7 2.1
2011 1.6 2.1 2.7 3.2 3.6 3.6 3.6 3.8 3.9 3.5 3.4 3.0 3.2
2010 2.6 2.1 2.3 2.2 2.0 1.1 1.2 1.1 1.1 1.2 1.1 1.5 1.6
2009 0 0.2 -0.4 -0.7 -1.3 -1.4 -2.1 -1.5 -1.3 -0.2 1.8 2.7 -0.4
2008 4.3 4 4 3.9 4.2 5.0 5.6 5.4 4.9 3.7 1.1 0.1 3.8

 

Source: US Inflation Calculator as published by Bureau of Labour Statistics

As at September 2014, treasury was operating under a surplus of $106 billion. However, the 2014 fiscal year operated with a huge budget deficit of $483 billion. This was due to acceleration of military costs of active duty and retirement benefits, supplemental security income and veteran benefits that all increased according to the Department of Treasury.

The performance of the US financial market is usually very unpredictable. In the financial market, past performance is never used to predict future performance as it can never be a guarantee to future happenings. Despite the many international occurrences that occurred in 2014 for instance the largest Ebola outbreak ever to happen in history, the financial market performed well. However, the year 2015 began at a low note with the stock market recording losses in January (Bureau of the Fiscal Service para. 3). February however recorded gains that reversed the January losses. The February gains were again reversed by March stock declines. The decline is an indication of a slowing economic growth. The key stock market indices fell in the last week of March, 2015. These are the Dow Jones Industrial Average and the S&P 500 index. The 2014 decline in corporate profits is said to be the main reason stock performance has begun in a low key in the year 2015. Investor confidence has been affected with March recording a reduction in trading volumes. The NASDAQ composite index also registered a negative change of -135.20 in the week ended March.

The key interest rates in the US are discount rate and the federal fund rates that determine the overall lending rates by the banks and the cost of borrowing to investors. According to the Wall Street journal, the Federal fund rate as at the week ended March 27th was at 0.12. In the last one year the federal interest rates hit a low of 0.08 and a high of 0.13. The discount rate on the other hand has stabilized at 0.75 in the last one year (Bureau of the Fiscal Service para. 5). The federal fund rate indicates that the cost of borrowing in the last month has increased as compared to last year. The yields on long term treasury securities have declined in the last few months with a 20 year treasury yield recording an average of 2.29 which is relatively low compared to the high 3.35 that was recorded last year.

Recession is a phase in a county’s economic cycle that is characterized by low economic activity, contraction of transactions, and decline in company profits, and scarcity of credit for all the sectors of the economy, low income levels by citizens and a decline in spending for consumers. The 2008 recession that nearly melted the U.S financial system is still being felt in the economy. According to the World Bank, as a result of the recession the country’s GDP reduced from $14.718 trillion in 2008 to $14.418 trillion in 2009. The economy has however steadily improved with 2010 recording a GDP of $14.964 (Bureau of the Fiscal Service para. 7). As at 2013, the economy had grown to $16.768 trillion. Though the corporate profits fell by 0.8 percent in the fourth quarter of 2014, the rest of the world fell by 8.8 percent indicating the US is still leading as a strong superpower.

Since the financial crisis of 2008, the economy has been growing at a slow disappointing rate of 2%. However, analyst anticipation of real growth in 2014 did not disappoint. It is also anticipated that the economy will grow more in the year 2015. Positive indicators point to accelerated growth in real assets, manufacturing activity and financial markets especially in stock tare. However due to uncertainty, it is expected that capital spending will not increase as much (Vanguard 12).

Inflation in developed nations tends to remain fairly modest.  Vanguard had anticipated the inflation to remain in a range of 1%-3% but it hit a low of 0%. This is indicative of a strong economy. Inflation is likely to remain at the low rate of 0% , while the highest rate it could go in the next two years is probably 3%.  However, there shall be an increase in economic activities with time. With the relatively average interest rates, the financial sector which is a sensitive sector will record increase profits (Vanguard 4). When interests are high, investors tend to invest in cyclical stocks as the rate of growth in cyclical stocks increases in times of economic growth. With these conditions, we would expect the defensive sector to experience low growth as compared to the aggressive sector. We would also expect the sensitive financial sector to grow compared to the defensive sector due to the relative average high prevailing interest rates. This is because the profitability of banks is dependent on the short term and long term rates. Banks normally borrow short term and lend long term to increase their yields.

Defensive and Aggressive Stocks

The question of the sector to invest in depends on the type of investor one is. There are two kinds of investors, the risk takers and the risk averse investors. With the slow and gradual growth the U.S economy is experiencing the defensive sectors are performing better than the aggressive sectors. Defensive sectors are those whose profit is not correlated to economic activity. The defensive sector remains stable despite low economic growth. For instance defensive industries like consumables always perform well in times of recession .This is because consumables such as food and drinks are wants that people cannot live without. In times of recession, people reduce their spending on necessities. This has also been reflected in the macroeconomic indicators where the economy growth was tied substantially to the defensive sector. According to the GDP statistics, the food, drinks and health care sectors recorded the highest growth in the last year. Investing in defensive sectors is playing safe in times of recession because companies are able to consistently pay shareholders dividends due to stable revenue. On the other hand, some industries in the defensive sector for instance telecom are capital intensive and therefore most of their projects are financed by massive debts. In case of higher interest rates due to healthy economies, the industries are faced with much pressure of increased cost of borrowing. This affects profitability, stock prices and therefore reduces dividend pay out to investors.

On the other hand, the cyclical or aggressive sector is the sector whose performance is dependent on economic activity. During recession, the profitability of industries in the cyclical sector reduce and also affects the share price by dropping. In contrast, when the economy is doing well, the sector relatively improves and profitability increases. Example of businesses in the cyclical sector is the automobile industry and other high tech companies. A person would never think of buying a car or an expensive phone when his income is low during recession. However, in times of economic boom, people spend money on luxurious gadgets due to increase in income levels. Moreover, an IT company during recession is unwilling to invest in new technology due decreasing profits as a result of a declining economic activity.

Understanding the concept of nature of the various sectors namely, cyclical and defensive is crucial for any investor. A successful investor will always aim at integrating the current economic situation in his or her investment decision. They will also identify possible future occurrences likely to happen though the performance of a stock in future in never dependent on it past performance. The macroeconomic indicators are resourceful tools of trying to anticipate the performance of a stock (U.S Department of Labor.  Para. 4). With the GDP percentages, it is clear that the defensive sector is really doing well as compared to the cyclical sector. The increase in employment levels also reveal that employment was created more in the defensive sector namely the food and drinks businesses and the health care sector. An investor’s choice of the sector to invest in depends on their goals. As earlier stated, the investment decision one’s make depends on the type of investor they are.  A risk averse investor will go for the defensive stock while a risk averse investor will go for the cyclical stock.

However, being a new investor in a foreign market, it advisable to be more of risk averse and invest in defensive stocks. This is because cyclical stocks require more knowledge of investing and one needs to be aware of where the economy is. Moreover, the cyclical companies have business cycles that are shorter than the defensive sector companies and an investor may not be aware of the current cycle of the company’s product ( U.S Department of Commerce para. 4). Projecting the future performance of cyclical products is also more difficult because a new technology being developed by a high tech company may be anticipated to perform well in the market but end flopping. Moreover, competition in cyclical product is often so high and investor may invest in a company that is performing well due to its new tech product and later a competing firm may launch a more advanced product affecting the stock of the company you have invested in.

Foreign investors should always play safe when investing in a new country. Though the cyclical sector is expected to grow with time. It is advisable for a new investor to invest in the defensive stocks (U.S Department of Commerce para. 4). Defensive stocks have a sustainable business model that is able to withstand any kind of market crisis. This is because their products are beyond necessities. For instance companies that sells food products, health care, gas and other wants.  Even in times of financial crisis the stocks still perform relatively better than cyclical stocks.

Diversification

Investment involves risk. In investing, it possible to even loss the principle (Vanguard 2). This mostly occurs when an investor puts all their money in one basket or in one sector. Diversification is an investment technique that enables an investor to maximize returns by spreading their risk over different industries, financial instruments and other investing opportunities. It is however impossible to avoid the market risk which is the risk associated with the whole economy (U.S Department of Labor para. 6). This is due to same inflation rates, exchange rates, interest rates and political situations that affect every company. This risk cannot be reduces through diversification. However, diversification reduces the unsystematic risk that is the risk specific to an industry and market. Even for a risk taker investor, it is advisable to diversify investments. In our case, a portfolio made up of defensive stocks and cyclical stocks will maximize returns through market capitalization.

Though the GDP shows that the defensive sector is performing, the stock indices reveal a different story. The NASDAQ index which is a composition of several technology companies has been performing better than the DJIA index which is a composition of 30 major American companies of different industries. Since the 2008 financial crisis, defensive stocks have outperformed other market stocks. However, they tend to perform less that other stocks in time of economic recovery as a result of increased risk investor appetite that in most cases favour cyclical stocks (U.S Department of Labor para. 8). Due to the recent financial crisis, it is wise for every investor to diversify their stock portfolio by investing partly in defensive stocks that are always a sure source of income to boost the portfolio while at the same time hold some stocks in the cyclical sector in order to retain some risks for higher returns.

Conclusion

The 2008 financial recession caused a major scare to investors. Most investors lost huge sums of money in the crisis and it is therefore advisable for investors to trend carefully. The US economy since the crisis has been growing a slow rate meaning that it is yet to fully recover. However, the economy still boasts of being the most dominant in the world even after the financial crisis that almost brought it to its knees. The unemployment rate has been declining meaning that jobs are being created which is an indication of growth. Moreover, the consumer purchasing power has increased since 2008 as a result of an increase in the level of incomes. The GDP has also improved since 2008 with last year’s gross domestic product reaching a high of $16 trillion. Economists are hopeful and anticipating growth in all sectors of the economy in a few years.

There are great opportunities of earning returns for foreign investors. However, an investor should have the available market knowledge to avoid making losses. As earlier stated, the defensive stocks have been performing well compared to the aggressive stocks due to their non-correlative nature to the economy. Aggressive stocks are also promising and have the ability to perform especially when an economy is in the process of recovery. However, diversification is necessary to maximize returns by spreading risk in other sectors to avoid losses.

Works Cited

Elwell. Craig. K. Economic Recover: Sustaining U.S Economic Growth in a Post-Crisis

            Economy. 2013.

GDP Increases in Fourth Quarter: Third estimate of GDP. Bureau of Economic Analysis U.S

Department of Commerce. Web. 31 Mar. 2015.

Monthly Treasury Statement of Receipts and Outlays of the United States Government. Bureau of

the Fiscal Service. 2014. Web. 31 Mar 2015.

The Employment Situation- February 2015. Bureau of Labor Statistics. U.S Department of

Labor.  Web. 31 March. 2015.

Vanguard Investment Counselling & Research. Defensive Equity Investing: Appealing Theory,

            Disappointing Reality.

Vanguard Investment Counselling & Research. Vanguard Framework for Constructing

            Diversified Portfolios. 2013.