The
Disconnect Between U.S. Equity Markets and the Economy is Accelerating
By Victor Sperandeo with
the Curmudgeon
Introduction:
The U.S. equity markets, and economy have been disconnected for
quite some time and that disconnect is accelerating. As weve said many times, its due to the
Federal Reserve Boards policy of feeding their masters (who are the material
owners of stocks) free fiat currency via seemingly endless rounds of Quantitative
Easing (QE). Instead of the newly
created Fed bond buying money going into the real economy, its been injected
into financial markets.
The Fed has also maintained short term interest rates at 0 to
25 bps (ZIRP or zero interest rate policy) for most of the last 12 years
and says that will continue into the near future without concern for
inflation. ZIRP encourages risk taking
and has turned many savers into speculators or even Reddit inspired day
traders.
The orchestrated decline/crash in money velocity has muted
inflation. Thats because banks would
rather keep their reserves on deposit with the Fed rather than loan money. The
Fed paying banks interest on required and excess reserves encouraged them to
not loan money, which in turn caused the steep decline in money velocity.
Over the last 12+ years, monetary policy and deficits have
had no negative consequences for the markets (or seemingly for the
economy). However, that will surely
change as per our Sustainability and Debt to GDP sections below.
Like the end of the USSR, change will happen suddenly. As Herbert Stein, the well-known economist of
the 1970s and 1980s said: If something cannot go on forever, it will stop!
When it will stop is impossible to know in advance, i.e., the timing is uncertain.
A Calvin Coolidge History Lesson:
The U.S. economy boomed under President Calvin Coolidge. The
rapid U.S. economic growth was known as the "Roaring Twenties."
Unemployment remained low while the country's gross domestic product rose from
$85.2 billion in 1924 to $101.4 in 1929. Yet U.S. federal government spending
declined and there was a budget surplus each year! Total federal government
spending in 1923 was $3.14 billion and in 1928 it was $2.96 billion.
Moreover, Coolidge worked tirelessly to reduce the burden of
taxation on the American people.
From his 1925 Presidential Inaugural Address:
The collection of any taxes which are not absolutely required,
which do not beyond reasonable doubt contribute to the public welfare, is only
a species of legalized larceny. Under this republic the rewards of industry
belong to those who earn them. The only constitutional tax is the tax which
ministers to public necessity. The property of the country belongs to the
people of the country. Their title is absolute.
The Revenue Act of 1924 reduced rates retroactively for 1923,
and by 1924 the top rate had come down to 46% of income over $500,000. Coolidges Revenue Act of 1926 again lowered
the top rate to 25%, retroactively for incomes over $100,000.
The U.S. economy flourished as a result of these enlightened
tax policies. Economic productivity increased, as did employment and income
levels. Also, the federal government collected more tax revenue in many years
after the Coolidge tax cuts were enacted than before, as a result of a growing
economy and many high-income earners deciding to invest their money in the real
economy rather than using tax shelters.
Sustainability:
Heres something to think about: U.S. federal government
spending went from $2.96 billion in 1928 to $ 8.025 trillion ($22 billion a
day) in 2020. Thats a mind-boggling increase of 267,400%!
Over 92 years, its a compounded annual increase in spending
of 8.96%. During the same time, there was an increase in revenues (taxes) of
7.62% yearly, according to the U.S. debt clock.
Last year taxes were $3.458 trillion.
Do you think U.S. government debt and spending increases are
sustainable?
CBO Report on the U.S. Economic Outlook:
Each January, the Congressional Budget Office (CBO) usually
puts out a 60-to-120-page report of their projections/overview for the next 10
years. But this year the CBO put out an
eight-page mini report titled, An Overview of the Economic Outlook: 2021 to 2031. Their forecast incorporates economic and
other information available as of January 12, 2021, as well as estimates of the
economic effects of all legislation (including pandemic-related legislation)
enacted up to that date.
The CBO projects Real GDP of +4.6% for 2021 (Year over Year),
with an inflation rate using the PCE (personal consumption expenditures) price
index of 1.6%. The budget office expects
the unemployment rate to fall to 5.3% at the end of the year, down from an 8.4%
projection in July 2020.
Some budget hawks worry that too much aid would risk wasting
money and stoking inflation. Its probably better to overshoot than
undershoot, but there can be too much of a good thing, said Maya MacGuineas,
the president of the Committee for a Responsible Federal Budget, a
nonprofit in Washington. Sending money to people who dont need it, overstimulating
the economy or unnecessary debt all set us up for more things to clean up
later.
Perhaps the best statistics in the CBO mini report are the forecasts
of GDP growth... Annual real GDP is projected to increase 4.6% in 2021,
2.9% in 2022, 2.2% in 2023, 2.3% average from 2024-2025, and 1.7% from
2026-2031 (without any recessions)?
Nonetheless, I take this CBO report to be worthless, as
without the specifics of spending and policy decisions, GDP and inflation can
change materially.
GDP Forecasts vs Reality:
My original forecast was that U.S. GDP would be +/- 1% from
last June, without fiscal stimulus starting after September 2020. In the 4th quarter
of 2020, real GDP was +0.99% (+4.0% annualized), while current dollar GDP was
+1.48% (+6.0% annualized).
Congress passed a $900 billion stimulus last December, which
the CBO says will add about 1.5% to the level of GDP this year and next. The Dems are now pushing hard for another
$1.9 trillion aid package, but the GOP hasnt agreed yet. The potential $2.8 trillion federal
government stimulus is about equal to 13% of nominal GDP and will certainly
boost U.S. economic growth. But what
else will short of a return to normal via the end of government shutdowns and
restrictions?
Goldman Sachs recently raised its U.S. GDP forecasts. Economists at the bank now expect GDP to be
6.6% in 2021 from 6.4%. Goldman expects
a 4.3% GDP growth in 2022 and 1.6% growth in 2023.
If you spend and print enough dollars you can get GDP up in
2021, which is possible, but no way can I understand CBO projected growth at
4.6% (or higher) with large sections of the U.S. economy still shut down.
Ill update my U.S. GDP view if and when Congress passes
another stimulus package.
ShadowStats View of U.S. Economy:
From John Williams February 1st note to
subscribers:
4th Quarter 2020 GDP came in as expected, with
continuing record deterioration in the Trade Balance, some retrenchment
in Durable Goods Orders and New-Home Sales. The consumer remains constrained by
liquidity, employment and related Pandemic issues.
Suffering from a Pandemic-driven systemic and economic
collapse, the 2020 annual decline in real GDP was the deepest since 1946, when
U.S. economic activity dropped by -11.16% in its post-World War II reset.
The Pandemic already has inflicted lingering, massive
structural damage on the United States economy and on the lives and psyche of
its people. Renewed, intensifying economic damage from pandemic appears likely
in at least the next quarter or two. Although one can hope that circumstances
will begin to stabilize, as vaccines and treatments begin to tame the pandemic,
continuing major, expansive Federal Reserve Monetary Policies already are in
place, and further, expansive new Federal Government Fiscal Policies already
are promised, and likely will be needed and will continue well into 2022 and
beyond.
The Feds Balance Sheet:
To understand U.S. economic growth and financial market
performance, one must examine the Feds balance sheet:
On 6/11/08 it was $890 billion. In 12.58 years (through 1/27/21) it is now
$7,404 trillion. Thats an increase of 18.3% compounded annually over 12.58
years.
Moreover, in the last year (from 10/2/19 to 9/30/20) the
Feds balance sheet went from $3.945 trillion to $7.056 trillion. Thats a hyperbolic increase of 78.9%. Heres
a six-month view of the Feds total assets:
Did all that Fed bond buying help the U.S. economy? You be the judge: GDP declined -3.5% for the full
year of 2020, the most since the 1929-32 depression. Furthermore, U.S. GDP has been way below trend
[1.] since the Fed announced QE1 on November 25, 2008.
Note 1. U.S. GDP Trend
Growth Rate:
GDP Annual Growth Rate in the U.S. averaged 3.17% from
1947 until 2020, reaching an all-time high of 13.4% in the 4th
quarter of 1950 and a record low of -9% (-31.4% annualized) in the 2nd
quarter of 2020. It has decreased over
the past 12 years due to the weakest U.S. economic recovery on record (from
June 2009 through February 2020).
.
U.S. Debt to GDP Ratio:
An under discussed and often ignored Risk Metric for
the U.S. is the Debt to GDP ratio.
Lets take a closer look.
- The current $27.8
trillion U.S. debt as of 2/2/21 is expected to reach $30-to-$31
trillion by September 30, 2021.
- Real
GDP decreased -3.5% in 2020 (from the 2019 annual
level to the 2020 annual level), compared with an increase of +2.2% in
2019.
Using the end of the 2020 calendar year Nominal GDP of $20.932 trillion and Real GDP of $18.422
trillion (official numbers as of Jan 28, 2021 from Current-Dollar and Real
GDP), the Debt to GDP ratio is 1.41% and 1.62% for Nominal and Real
GDP, respectively. Those ratios assume a
$31 trillion stated U.S. debt and a 6% Gross GDP with 2.2% CPI inflation.
The unsustainable number is a jaw dropping 10-year debt
projection of $73 trillion in 2031, based on the U.S. 50-year trend
of increasing budget deficits of 9% a year.
Therefore, in 10 years at CBO projected growth rates (their
GDP forecasts are historically high) and the 50-year trend in deficits of 9%, the
U.S. Debt to GDP ratio will be 3.04% - the highest in the world! Compare
that to todays world leader- Japan at 2.50%.
As anyone can see, the above numbers are not sustainable!
Impact on U.S. Stock Market:
According to the Wall Street Journal, the trailing P/E [2.] of the S&P 500 is 43.92
(vs 26.10 one year ago). The Schiller P/E is currently 35.39 (vs a median of 15.81). According to Investopedia, the average P/E for the S&P 500 has historically ranged
from 13 to 15.
Note 2. Forward P/E Ratios Are Worthless:
We ignore forward P/E estimates because they are often based
on wishful thinking, erroneous assumptions, and analyst bias. They seem to
always overestimate earnings to suggest much lower forward P/E ratios one year
out. A classic example of this was the
Russell 2000 forward P/Es since the great recession ended in June 2009 till
the present time.
.
With P/Es on U.S. stocks being this high, and CBO projected
GDP growth for the next 10 years of ~ 2.1% per annum, there is no room for P/E
expansion. Moreover, its operating
earnings growth not P/E expansion- that drives equity valuations higher over
the long run.
Where is future earnings growth to come from that would
justify higher stock prices? Or will
P/Es expansion continue indefinitely?
Victors Conclusions:
I have stated since March of last year that the U.S. is in deep
decline. In April, I stated that pandemic induced shutdowns were equivalent to
economic suicide as per our article that month titled, Perspective
on U.S. Economy and the Coronavirus Suicide is NOT Painless! Sadly, my view for the long run is much
worse today.
Based on the politics Ive observed, things in general will
get worse with only brief pauses of relief happening with government spending
and continued Fed money printing. The future of the U.S. is dire!
Furthermore, investing is not a viable concept anymore.
Following the Fed and federal government stimulus packages have become the most
popular mode of trading markets, in my view. Investing, based on earnings
growth and valuations is largely a thing of the past.
Most people believe inflation, is coming. That might end the Feds one trick pony of
printing MONEY TO SAVE THE DAY.
Inflation sensitive commodities are finally in an uptrend and
outperforming stocks since the end of 2020.
The U.S. economic decline is saddest for the children of
today, who will in general never have the same standard of living as their
parents.
My greatest wish is that Im dead wrong!
Closing Quotes and Key
Takeaways:
Nothing in our material world, regardless of the form of
government, can come from nowhere or go nowhere, nor can it be free: everything
in our economic life was produced by taking risks, and has a source, a
destination, and a cost that must be paid by someone (or everyone by inflation)
somewhere.
From Dreams Come Due by John Galt.
...
This quote says it all in the historical cycles of mankind:
A democracy cannot exist as a permanent form of government.
It can only exist until the voters discover that they can vote themselves
largesse from the public treasury. From that moment on, the majority always
votes for the candidates promising the most benefits from the public treasury
with the result that a democracy always collapses over loose fiscal policy,
always followed by a dictatorship. The average age of the world's greatest
civilizations has been 200 years. These nations have progressed through this
sequence: From bondage to spiritual faith; From spiritual faith to great
courage; From courage to liberty; From liberty to abundance; From abundance to
selfishness; From selfishness to apathy; From apathy to dependence; From
dependence back into bondage.
by Alexander Fraser Tyler (1747-1813).
.
The key takeaway is the cause of abundance is
Liberty, which is the basis of the Constitution and the Declaration of
Independence.
Where do you see any current Congressman or leaders mention
liberty? Without it, we trend to bondage! Can anyone deny our liberty is
virtually gone?
Pop quiz: Within 5 minutes, I challenge the reader to name
three things you can do without government permission or license?
..
Lets hope for a return to normal soon as more people are
vaccinated. Till next time
.
The Curmudgeon
ajwdct@gmail.com
Follow
the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has
been involved in financial markets since 1968 (yes, he cut his teeth on the
1968-1974 bear market), became an SEC Registered Investment Advisor in 1995,
and received the Chartered Financial Analyst designation from AIMR (now CFA
Institute) in 1996. He managed hedged equity and alternative
(non-correlated) investment accounts for clients from 1992-2005.
Victor
Sperandeo is a historian, economist and financial innovator who
has re-invented himself and the companies he's owned (since 1971) to profit in
the ever changing and arcane world of markets, economies and government
policies. Victor started his Wall Street
career in 1966 and began trading for a living in 1968. As President and CEO of
Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and
development platform, which is used to create innovative solutions for
different futures markets, risk parameters and other factors.
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