At the time of this writing, the stock market was hitting all-time highs – even as many of us likely faced a healthy April 15th tax bill thanks to the inevitable capital gains from the amazing stock rally of the last 3+ years.
Stock prices have been incredibly resilient despite sticky inflation (possibly made worse by the Gulf oil mess), concerns bubbling up from the private credit markets, zero net job creation, and a U.S. budget deficit that continues to worsen. But investors care most about company earnings. When we invest in stocks, we generally do so because we expect future earnings growth. And earnings have been strong…and thanks to productivity gains, are expected to remain strong.
Productivity, in simple terms, measures how much output the economy generates per hour worked. It rises when workers become more efficient, when firms equip them with better capital or when resources shift toward higher-value activities. All three appear to be at work today, but as tempting as it is to credit artificial intelligence (AI) for this, it would likely be premature. That is because technological revolutions (and AI is going to be a massive one for sure) typically do not lift measured productivity immediately. Instead, they follow a J-curve, as firms spend heavily upfront to reorganize the technology while the payoff arrives later.
Non-AI factors that have already boosted productivity include:
- Pandemic restructuring: The pandemic reshuffled labor and business formation in ways that may have raised average efficiency. Lower-productivity firms were disproportionately disrupted, digital processes were adopted quickly economy-wide and the "Great Resignation" likely improved job-matching
- Capital deepening: U.S. firms had already been investing heavily in software, intellectual property and R&D before the current Al race. With modernized capital equipment and software, productivity gains can compound over time
- Labor scarcity: A tight labor market, exacerbated by a sharp slowdown in immigration, pushed businesses to substitute capital for labor by investing in software and automation and demanding more output from existing workers
If the productivity/earnings boost we have already seen can get better when companies really learn to leverage AI, then that is a very good explanation for the stock market’s exuberance. As the old Wall Street adage goes, the market always looks ahead.
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References to artificial intelligence or technological developments are general in nature and do not imply positive investment outcomes. All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. The return and principal value of stocks fluctuate with changes in market conditions. Shares when sold may be worth more or less than their original cost. Comments regarding market conditions, earnings, productivity, or economic trends are forward-looking, reflect current views, and are not guarantees of future results.