Wall Street is in economic denial


We know the US economy is weak right now, but the real economy is really weak, and the Federal Reserve’s commitment to precipitating a recession to rein in high inflation will make that reality obvious to seemingly oblivious investors.

Real gross domestic product has fallen for two straight quarters, and while the National Bureau of Economic Research has yet to say a recession is underway, those focusing on nominal, non-inflation-adjusted numbers high, still hope that a business slowdown can be avoided. They talk about rising wages in a tight labor market with low unemployment and job openings outstripping the number of unemployed. The hourly wage in nominal terms is up 8.8% since May 2021.

But adjusted for inflation, real wages have fallen every month since then, bringing the cumulative decline to 3.2%. Even nominal wage growth is slowing, with the annual growth rate of 5.6% in March slowing to 5.2% in July. When other sources of personal income are included – benefits, landlord income, rent, interest, dividends and government benefits – and income taxes are subtracted, personal disposable income rose 6.8% in the second quarter compared to the previous year, but fell by 0.6% after adjustment. for inflation.

Those who think consumer spending is robust are confusing inflation overlays with the real economy. Since March 2021, nominal retail sales have increased by 6.9%, but have fallen by 4.1% in real terms.

Denial of the ravages of inflation was also widespread in the late 1960s and 1970s, when huge federal spending on the Vietnam War and Great Society programs pushed the economy into double-digit inflation. Despite the Johnson administration’s belief, the economy lacked the labor supply or industrial capacity to produce both arms arsenals (military spending) and butter (civilian goods) .

Business costs soared as CEOs felt pressured to keep employees at least in step with soaring prices. Thus, not only nominal wages have increased, but also real wages. At the same time, the depreciation of fixed assets, based on historical costs, was well below the funds needed for replacement. In addition, inflation has created taxable inventory profits. The dollar value of stocks jumped even though the physical size of stocks did not change.

I pleaded with our corporate clients at the time to look at their company’s results in real terms to see how much damage inflation had done. The universal answer has been that Wall Street doesn’t care about actual results, so why should they? And while the Dow Jones Industrial Average, in nominal terms, hovered around the 1,000 level from the late 1960s to the late 1970s, in real terms it plunged 73.1% from January 1966 to July. 1982.

Despite the current high inflation, some shareholders are also in a state of denial. On August 16, Walmart Inc., the nation’s largest retailer by volume, reported revenue growth of 8.4% in the quarter ended July 31 from a year earlier, less than the rise in 8.5% of the consumer price index. The retailer’s grocery sales volume fell in the quarter and operating profit fell 6.8% due to higher discounts and the sale of more low-margin grocery items. Still, investors pushed Walmart shares up 5.1% on the day of that announcement.

On August 23, Macy’s Inc., the largest department store chain in the United States, lowered its forecast for this year due to the economic slowdown, slowing consumer spending and markdowns and promotions to get rid of excess inventory . Sales at stores open for at least a year fell 1.5% in the second quarter from a year earlier. Still, shares of Macy’s closed up 3.8% that day.

Today’s high inflation is clearly eroding corporate earnings. From the second quarter of 2021 to the second quarter of this year, business gross value added (in effect, business sales) increased by 12.7% in nominal terms, but only 5.1% in real terms. After-tax corporate profits fared worse, rising 7.4% but only 0.1% when adjusted for inflation.

Inflation may have peaked, but will likely decline slowly. So the 5% increase in S&P 500 earnings that Wall Street analysts expect for 2022, as reported by S&P Global, will equate to an actual decline. Investors will undoubtedly pierce the veil of inflation and focus on growing weakness in real corporate earnings and profits. This may be part of the reason for the recent rally in equity sell-offs. My previous forecast of a full 40% decline in the S&P 500 from the peak in early January still stands.

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This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Gary Shilling is president of A. Gary Shilling & Co., a consulting firm. He is the author, most recently, of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation,” and he may have an interest in the areas he writes about.

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