Stocks Versus the Economy
Post from First Trust Economics Blog
Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist
Sept 13th, 2021
If you’ve read our two most recent Monday Morning
Outlooks, you know we raised our forecast for the S&P 500, but
lowered our forecast for real GDP growth. How can that be?
The first thing to recognize is that when we say we’re
bullish on stocks that doesn’t mean we think the stock market is
going to go up every day, every week, or even every month. It
won’t. Nor does it exclude the possibility of a correction in
equities, which based on historical frequency is past due.
We take a fundamental approach, valuing time in the
market over trying to time the market. Corrections will happen
from time to time, and we don’t know anyone who can accurately
forecast them on a consistent basis.
Without digging deeply into our capitalized profits model
which estimates a fair value for stocks as a whole, we remain
bullish for three main reasons. First, long-term interest rates are
low and are likely to remain relatively low for at least the next
year. Second, corporate profits are very high and will remain
relatively high even if they pull back from record highs as the
amount of government “stimulus” wanes.
Third, even if real (inflation-adjusted) GDP growth falls
short of consensus expectations in the next few years, nominal
GDP (which includes both real GDP growth and inflation),
should remain robust due to the Federal Reserve’s overly loose
monetary policy – see point one above – which will remain
extremely loose even as the Fed starts tapering later this year and
ends quantitative easing around mid-2022.
The key problem for real GDP is that the massive and
unsustainable fiscal stimulus and income support that happened
during COVID pushed retail sales well above the pre-COVID
trend. Retail sales in July were 17.5% above the level in
February 2020. To put that in perspective, in the seventeen
months before COVID, retail sales were up 5.1%. There is only
one way retail sales can grow 3x its normal rate while millions
are unemployed and the economy was locked down – the
government pulled out the credit card.
Those handouts are now slowing down and retail sales
likely dropped in August (official data to be reported Thursday
morning) and are likely to moderate from the 17.5% peak growth
rate, on a trend basis, for at least the next year.
Retail sales make up about 30% of GDP. So other sectors
of the economy will need to pick up the slack – replenishing
inventories, home building, and the consumption of services,
such as travel and leisure activities. But, after such massive
artificial stimulus, it will be difficult for real GDP to keep
growing as it has in the past nine months.
GDP includes revenues that are earned by publicly traded
companies, but it also includes Main Street businesses that are
not listed. It is those latter businesses that have been hurt the
most by lockdowns. That’s one reason listed-company profits
and their stock prices have outperformed the economy.
The bottom line is that we are bullish for now, but fully
recognize that we have been in a pristine environment for stocks.
A slowdown in GDP will likely slow profit growth, while rising
inflation will eventually lift long term interest rates. Tax hikes
are still a threat, as are tougher COVID-related restrictions that
limit a service-sector recovery. However, with the Fed as easy
as it is, the tailwinds from easy money remain strong. The
market is not overvalued, but it is not as undervalued as it once