The Disconnect Between Stocks and the Real Economy

Stocks continue to fly higher than ever after the Trump rally that started in November 2016.

In fact, since the bottom in early 2009, stocks have grown at a compound rate of 37% per year, with earnings per share growing at 21% (GAAP). But in that same period, total corporate profits grew only 8%, corporate sales 4%, and real GDP 2%…

That’s the real economy, with corporations faring better than consumers who aren’t seeing their real wages grow. The record stock bubble in both time (8.8 years now) and total gains (315%) has been running more on the QE free lunch… and now the tax cuts.

Look at this chart that compares earnings per share (EPS) with corporate profits…

Look at that! Two different worlds.

Why?

Because QE and tax cuts provide cheap money for companies to buy back their own stock and leverage the slower earnings trend.

Normally total stock shares expand about 2% a year, but since 2009 they’ve contracted 1% a year. That would compound to a 30% difference over nine years!

Other analysts like David Rosenberg say it’s a 15% shrinkage, but it’s more like 30% when you account for the total swing from normal (2%) to current (-1%).

The constant bid from corporate buying also puts a floor under the market with very little downside corrections. Not just less supply of stock, but more demand. Hence, the total impact has to be 40% to 50%. Without this, the Dow could be at 16,000 – 18,000 instead of 25,000.

 

Then there’s the promise that tax cuts will cause GDP growth to accelerate – maybe for a quarter or two…

The next chart shows that since the late 1990s – the tech bubble – capital investment has not been keeping pace with corporate profits.

Companies aren’t reinvesting.

Dr. Lacy Hunt picked this up a long time ago when he showed that money velocity has been falling since its peak in 1998. This means that companies and investors are notmaking productive investments in the future. Rather, they’re making speculative ones, like stock buybacks. And that creates bubbles in financial assets while the real economy slows.

Exactly what’s been happening.

You’ve got to ask yourself: why would companies re-invest when nine years of free money didn’t increase capital investment substantially?

It’s because corporations are running at a low 75% capacity. They don’t need more capacity!

They keep getting rewarded for using cheap or free money to buy back their stocks and initiate mergers and acquisitions that only rearrange the pie, but don’t increase it.

Expect more of the same – inflated markets disconnected from the real economy – after a brief surge of bonuses to employees, as we saw at Wal-Mart last week.


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