US GDP - Cyclical Position, Profits, S&P Valuations
In volume terms, GDP rose an annualized 6.9%, which was stronger than the 5.7% consensus expected, and a sharp acceleration from the 2.3% annualized in 3Q. But that strength is misleading, since approximately 74% of the qoq growth recorded in 4Q came from a build-up of private inventories. There's no way of knowing how voluntary that build-up of inventories was: remember, yesterday we reported retail inventories up 4.4% in Dec after retail sales fell 1.9% - which doesn't sound voluntary to me.
Strip out inventory movements, and final sales of domestic product rose only 1.8% annualized - pretty much a crawl. Within that, the star was personal consumption up 3.3%, but non-residential investment was running at just 2% and residential investment fell 0.8%. Despite the headline growth rate, this was not, then, a strong result, or one suggesting a strong cyclical impulse.
What of profits? The principle behind the Kalecki profits equation is that corporate profits must be equal to net investment, minus the savings imbalances of the rest of the economy - in practice that means the government, the household sector, and interactions with other economies.
In the 12m to 4Q, profits fell 0.5% qoq, and rose only 2.8% yoy. The main thing boosting profits during the pandemic was the extraordinary rise in the fiscal deficit - and the main factor now dragging it down is the continuing moderation of that fiscal deficit. That will remain true for the foreseeable future. In the meantime, profits are still a far higher proportion of GDP than previously - 30.3% in the 12m to December, vs a pre-covid long-term average of 24.6%, with a standard deviation of 2pps.
The key question is whether h'hold dissaving can rise faster than the fiscal deficit narrows. I think its' unlikely: savings rates are back to pre-covid levels, and dissaving/GDP is running at 13.9% of GDP, vs a pre-covid average of 14.6%. There's not a great deal of room to raise that proportion, so I think profits will remain under pressure in the short and medium term.
What do today's numbers do for S&P valuations? The Coldwater Slow Model considers that an asset is fairly valued when it maintains is value relative to the economy. In practice, I take the Kalecki profits and discount them based on l/t nominal GDP growth rates and volatilities. That model has tracked the S&P well since 1990, and continued to do so last year. On that basis, it told us the S&P 500 was approximately 10% overvalued at year-end when it was at 4766, and even if profits stabilized (which I don't think they will) then its still about 3% overvalued today.
If profits continue to fall - so will that valuation. Given the sharp downturn in economic data in January, it's difficult to expect an S&P recovery any time soon.
