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The market is reaching new highs, but the future still looks a little hazy

October 29, 2021

Any of you that took High School or College economics are familiar with Keynesian Economics. Keynesian economics is a macroeconomic theory of total spending in the economy and its effects on output, employment, and inflation. Keynesian economics was developed by the British economist John Mayard Keynes during the 1930s in an attempt to understand the Great Depression. Keynesian economics is considered a "demand-side" theory that focuses on changes in the economy over the short run.
Based on his theory, Keynes advocated for increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the depression. Subsequently, Keynesian economics was used to refer to the concept that optimal economic performance could be achieved—and economic slumps prevented—by influencing aggregate demand through activist stabilization and economic intervention policies by the government.

Keynesianism can temporarily giveth, but ultimately always taketh away...and then some.

When the US fell into the COVID crisis, the federal government went on a massive spending binge. Pre-COVID, in the twelve months through March 2020, federal outlays were $4.6 trillion, or 21.4% of GDP. In the next twelve months outlays soared to $7.6 trillion, or 36.2% of GDP. Outside of wartime, we know of no other time when the government has ramped up spending that much or that fast. As a result, as well as very easy money, the economy partially bounced back faster than it would have in the absence of extra spending.

But the extra spending was like an opioid given to a car crash victim, temporarily masking the economic pain caused by government-imposed shutdowns. Ultimately, there is no free lunch when it comes to spending, and the economic bill is already starting to come due.

As recently as early August, the consensus among economists was that real GDP would grow at about a 7% annual rate in the third quarter, even faster than it grew in the first half of the year when the government was passing out checks like it was going out of style. Now, as we set out below, we're estimating that the economy grew at only about a 2% rate.

I am not going to give you all the numbers that make up that estimate because most of you are not interested, but when you combine Consumption, Business Investment, Home Building, Government Spending, Trade, and Inventories, we get 2.0% annualized real GDP growth for the third quarter, nowhere close to the "sugar high" 6.5% annual rate of growth in the first half of the year.

This slow down in the economy is real and only the corporate earnings tell the true story of where the stock market is headed.

According to FactSet Research, we have received results from about 23 percent of the S&P 500 component companies as of Friday last week. Of the 23 percent that have reported results, 84 percent of the companies have beaten earnings expectations while 4 percent have met expectations and 12 percent have fallen short. The percentage of companies beating earnings expectations increased by 4 percent last week when compared to the previous week. When looking at revenue expectations, 75 percent of the companies that have reported have beaten expectations while 25 percent have fallen short.

This is why the market is reaching new highs, but the future still looks a little hazy as the slowdown in the economy is beginning.

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