By David Stockman, Budget Director under President Reagan and author of the bestseller, The Great Deformation: The Corruption of Capitalism in America. This article originally appeared on David Stockman’s Contra Corner.
Based on the data releases to date, Q1 GDP is trending at a tepid 1.5% growth rate. But do not be discouraged. It’s all due to the weather! So say the Wall Street economists who are now predicting a spring-summer boom for the fifth year running. Notwithstanding the fact that they have been dead wrong each time. But somehow this time is different – “escape velocity” is just around the corner.
There is a very simple reason why Wall Street’s so-called economists and strategists keep spotting a return to robust 3-4% GDP growth: it’s already priced into the stock market. Without many years of accelerating growth, there is no possible case for “buying the dips,” yet the essential function of Wall Street economists is to peddle exactly that proposition.
It is already evident, however, that S&P 500 earnings will show virtually no year-over-year growth in Q1, and are trading in the range of 19X reported LTM profits. That means that the market multiple is at the top of its historic range and cannot possibly remain there unless there is a sharp acceleration of corporate sales growth – and very soon.
After all, earnings growth can’t come out of still higher corporate profit margins. They are already way above their historic range. So unless GDP growth takes off, there is no possible route to the kind of vigorous earnings rebound required to justify 19X – to say nothing of buying new positions on the shallow dips that come along every couple of months.
In truth, the US economy is freighted down by “peak debt” and is incapable of the conventional credit-fueled rebound cycle that the Fed has orchestrated in the past. As should be evident by now, our national LBO is over. With $59 trillion of public and private credit market debt, the US leverage ratio stands at 3.5X national income – massively above the 1.5X leverage ratio that was compatible with healthy, stable economic conditions before 1980. The two extra turns of leverage laid on the economy over the past 35 years is exactly what blocks the “escape velocity” that Keynesian economists and Wall Street stock peddlers continuously espy just around the bend.
In fact, the evidence that the US economy is stuck in a 2% growth track – that is, spending growth is limited to the growth rate of production and income – is persuasive. Just look at the year-over-year growth rate of real final sales in the GDP accounts since the 2009 bottom.
This eliminates the seasonal maladjustments which confuse the quarter/quarter data, as well as the huge fluctuations in short-run stocking and de-stocking of inventory. Even then, the numbers are overstated because the GDP deflator average of 1.5% over the last five years is just not credible. No one but an iPad-addicted ascetic has had a cost of living gain that low since the financial crisis.
The year-over-year gain in real final sales was 1.9% in Q4 2013; 2.5% in Q4 2012; 1.8% in Q4 2011; and 2.0% in Q4 2010. Economic growth hewed to the flat line – notwithstanding the massive money printing by the Fed – because after a three-decade-long party, the American economy has way too much debt and has generated way too little real savings and investment in productive assets.
Yet now we are in month 58 of this recovery cycle – compared to an average expansion of 53 months during the 10 postwar business cycles. That is, on a calendar basis this so-called recovery is already on borrowed time, but actually the true condition is much worse because now there are headwinds coming from nearly every direction on the economic compass.
On the international scene, Abenomics is failing catastrophically in Japan. The Chinese house of cards is becoming shakier by the week. The emerging market economies, which boomed on cheap capital inflows owing to financial repression by central banks in developed economies and as the supply base for the Chinese building spree, are heading for devastating financial crises and recessions.
By David Stockman. Check out his bestseller, The Great Deformation: The Corruption of Capitalism in America, and while at it, check out my 5-star review (in 2nd place). This article originally appeared on David Stockman’s Contra Corner.