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

was.