Take note: what’s going on today in the economy and in the markets is not unprecedented or extraordinary. Below are 6 charts to support said contention.
This article is an edited ([ ]) and revised (…) version of an article by Scott Grannis to ensure a faster & easier read. It may be re-posted as long as it includes a hyperlink back to this revised version to avoid copyright infringement.
Current US Economic Expansion
The defining characteristic of the current US economic expansion is its meager 2.1% annualized rate of growth, which stands in sharp contrast, as the chart above shows, to its 3.1% annualized rate of growth trend from 1965 through 2007. If this shortfall in growth is due, as I’ve argued over the years, to misguided fiscal and monetary policies, then the US economy has significant untapped growth potential and could possibly be $3 trillion larger today if policies were to become more growth-friendly.
Value of US equities Relative to GDP
As the chart above shows, the value of US equities relative to GDP tends to fluctuate inversely to the level of interest rates. This is not surprising, since the market cap of a stock is theoretically equal to the discounted present value of its future earnings. Thus, higher interest rates should normally result in a reduced market cap relative to GDP, and vice versa. Since 10-yr Treasury yields—a widely respected benchmark for discounting future earnings streams—are currently at near-record lows, it is not surprising that stocks are near record highs relative to GDP. If the economy were $3 trillion larger, however, stocks at today’s prices would be in the same range, relative to GDP, as they were in the late 50s and 60s. Valuations are relatively high, to be sure, but not off the charts nor wildly unrealistic.
S&P 500 Index Valuation
Adjusting for inflation, we see that stock prices tend to rise about 3% a year, and the current level is not unreasonably high, as it was in the late 1990s.
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My reading of the economic and financial tea leaves is that the economy continues to grow at a sub-par pace (about 2%), just as it has for the past 8 years. I don’t see evidence of a coming boom, or of an imminent bust… just more of the same. Dull. Here are a baker’s dozen charts, with the latest updates, to flesh out the story:
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