Was the second quarter the highest economic growth and profits? If the estimates are correct and year-on-year “Base Effects” fades, suggesting a risk for current earnings estimates.
The graph of a “Very defective product” uses the Atlanta Fed’s current estimates for GDP for the second quarter of 2014. Full-year estimates come from JP Morgan. It should be noted that the economy is slowing rapidly to 2% by 2022.
Growth estimates are misleading for two reasons.
- As shown above, growth is recorded as an “annualized” rate. Growth of 6.4% in the second quarter means that real growth of 1.6% will be repeated over the next three quarters. (1.6% x 4 quarters = 6.4%) Historically, this feat never occurs.
- Second, the increase in growth in the second quarter depends on the contraction in the second quarter of 2020. As such, the growth rate is worsening. (This is the “base effect”). This growth rate will fall sharply during the third quarter as the base effect is reversed.
Such was a point by Goldman Sacks recently, as Zerohedge noted:
“Goldman lowered its growth forecast for consumption in the second half of 2021, leading to a 1% decline in GDP growth forecasts for the third quarter and fourth quarter to + 8.5% and + 5.0%, respectively. This is due to the fact that it is clear that the recovery of the services sector in the US is unlikely to be as robust as the bank expected. This is strange given the trillions of monetary and fiscal stimuli that have entered the economy.
But while Goldman’s projected slowdown for 2021 is manageable, much worse in 2022, when slowness is expected to really hit the growth rate, which Goldman now expects to reduce to a trend of 1.5% to 2% in the second half of 2022, a very slowdown stronger than expected consensus “.”
Although Goldman’s prospects may impact more “Effervescent Bulls”, it aligns well with ours previous analysis completed the last twelve months.
A decrease in spending
The immediate impetus for economic growth during the third quarter of 2020 through the second quarter of 2014 was the massive amount of federal spending. From the expansion of unemployment benefits to direct checks on households, the increase in consumption was evident. However, it did not translate into stronger economic growth or employment. The following graph is from “Inflation does not come from artificial growth.”
“Sustainable inflation, driven by demand, requires sustainable wages to support higher prices. Due to the artificial stimulus, personal consumption expenditures are 7% higher than pre-pandemic norms, while employment is ~ 6 million lower occupations ”.
Now the challenge is to reduce federal spending drastically. While there may be an eventual infrastructure plan, this expense will be spread over ten years. More importantly, as we will review below, federal spending is hurting economic growth.
Given the decline in federal spending and the potential reduction in the“ an inversion of growth is evident. The only question is whether current estimates remain too optimistic.
Despite this, we review the above analysis on why federal spending has minimal impact on growth.
A negative multiplier
There is almost no multiplier effect with federal spending. The study, related to the previous article, from the Mercatus Center of George Mason University, conducted by economists Jones and De Rugy, states:
“The multiplier analyzes the return on economic production when the government spends a dollar. If the multiplier is greater than one, it means that government spending attracts the private sector and generates more private consumer spending, private investment, and exports to foreign countries. If the multiplier is less than one, government spending eliminates the private sector, reducing it all.
Evidence suggests that government procurement is likely to reduce the size of the private sector as it increases the size of the public sector. In the network, revenue is growing, but privately produced revenue is declining. “
Personal consumption expenditures and business investment are vital contributions to the economic equation. As such, we must not forget the reduction in private production revenues. In addition, according to the best available evidence, the study found:
“There are no realistic scenarios where the short-term benefit of the stimulus is so great that government spending pays for itself. In fact, the positive impact is small and much smaller than economic textbooks suggest. ”
It should be noted that politicians spend money based on political ideologies rather than sound economic policy. Therefore, the conclusions should not surprise you. However, the conclusion of the study is very revealing.
“If you believe that the current monetary policy of the Federal Reserve is reasonably competent, you should not expect the tax increase on all this spending to be large. In fact, it could be close to zero.
That is, of course, all before you consider future taxes. When economists like Robert Barro and Charles Redlick studied the multiplier, they found once you consider the future taxes needed to pay the expense, the multiplier could be negative “.
What shouldn’t surprise you is that non-performing debt doesn’t grow economic growth. As Stuart Sparks of Deutsche Bank noted earlier:
History teaches us that, although investments in productive capacity can, in principle, increase the potential for growth ir * so that the debt contracted to finance the fiscal stimulus is paid over time (rg <0), it turns out that there is little evidence that has ever been achieved in the past.
The following graph illustrates that a The increase in federal debt as a percentage of GDP has historically been linked to declining r * estimates: the need to save debt in service depresses potential growth. The general point is that aggressive spending is necessary, but not enough. Expenditures must be designed to increase productive capacity, potential growth and r *. If there are no real investments, public spending can reduce the *, passively reducing the fixed monetary position ”.
A long-term historical look confirms this. Since 1977, the average ten-year GDP growth rate has steadily declined as debt has risen. Thus, using the historical GDP growth trend, the increase in debt will lead to a slower rate of economic growth in the future.
Given the historical correlation of debt with GDP growth, this suggests that future outcomes will not be different.
A review of earnings
Given that the profits and profits of companies are ultimately derived from economic activity (personal consumption and business investment), current high expectations are unlikely to be met.
The problem of investors today. Analysts ’assumptions are always high and markets trade at more extreme valuations, leaving little room for disappointment. Using the analyst’s 4700 price target assumptions for 2020 and current earnings expectations, S&P is trading at 2.6x growth.
Thus, the current P / E is in the gains of 25.6 times in 2020, which is still expensive by historical measures.
This also places the S&P 500 above its linear trend line as earnings growth begins to reverse.
Until the end of this year, companies will guide profit estimates for several reasons:
- Economic growth will not be as robust as expected.
- A potentially higher corporate tax rate could reduce profits.
- The increase in entry costs due to the stimulus cannot be passed on to consumers.
- Higher interest rates that increase debt costs that affect profits.
- A weaker consumer than currently expected due to reduced employment and lower wages.
- Global demand is weakening due to the strong dollar affecting exports.
This will leave investors once again “Pay more” for a growth of profits that does not materialize.
While none of this suggests the market will “Crash” tomorrow, it supports the idea that future yields will be substantially weaker in the future.
There are few, if any, Wall Street analysts expecting a recession right now. Instead, most are confident of an upcoming cycle of economic growth. However, at this time, there are few catalysts that support this resurgence.
- Economic growth outside China remains weak
- Employment growth will slow.
- There is currently no massive disaster driving an increase in government spending and reconstruction.
- There is no other package of incentives like tax cuts to boost corporate profits.
- With the projected deficit set to rise to $ 4 trillion, this year there will only be an incremental increase in additional deficit spending.
- Unfortunately, it is also only a function of time until a recession occurs.
Wall Street is famous for having lost significant turning points in the markets and leaving investors struggling for exits.
While no one on Wall Street told you to be careful with the markets in 2018, we did. Of course, we also warned in early 2020. but he fell largely into deaf ears “FOMO” cloudy basic investment logic.
It is likely that before we reach the end of 2022 it will happen again.
s.parentNode.insertBefore(t,s)}(window, document,'script', 'https://connect.facebook.net/en_US/fbevents.js');
Sometimes we include links to online retail stores. If you click on one and make a purchase we may receive a small commission.