January 10, 2021

Why This Market Rises

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The Bottom Line: 


The stock markets reacted positively to the Georgia election results, believing that more Democrats in power means more near-term deficit spending. The bonfires on the Capitol steps made for jarring imagery and histrionic journalism, but they couldn’t halt the pursuit of historic stock market highs.  Mixing more public sector deficit spending with more vaccine-induced private sector spending AND a 25% expansion of the US money supply will unlock record GDP growth, record corporate profits and even more record highs for stock markets. 


The Full Story:


Democrats surprised the seemingly permanentlysurprised pollsters by securing both Senate seats in Georgia on Tuesday.  With victory, the Democrats now have control of the House of Representatives, the White House and the Senate.  Fear swept across the Twittersphere as talk of granting statehood to DC and Puerto Rico, ending the filibuster rule, and stacking the Supreme Court added adrenaline to the already caffeinated conspiritists.  By weeks end, protestors had stormed the Capitol amidst cries for Donald Trump’s impeachment.  I heard one breathless broadcaster call it the darkest day in American history. Nonetheless, equity markets rallied smartly to new highs.  For those wondering why, I’ll explain! 



Less Lockdowns = Less Growth




The Federal Reserve uses regression analysis to forecast the potential growth rate of the US economy.  The blue line above chronicles their estimates for uninterrupted US economic growth.  Unfortunately, US economic growth experiences periodic interruptions (also known as recessions), requiring growth to accelerate above trend to recapture potential.  The US economy, as measured by real GDP, hit $19.2 trillion prior to COVID.  The COVID divot reduced national GDP to $17.3 trillion.  Fortunately, aggressive monetary and fiscal stimulus led to an historic recovery in GDP, and by the end of the third quarter almost 2/3 of what had been lost was recaptured.  Analysts expect fourth quarter GDP will rise another 1%, taking GDP up to $18.7 trillion.  This still leaves us $500 billion below potential.  Therefore, adding together the 2.5% normal growth rate with the 2.5% recovery rate projects a 5% GDP growth rate over the next twelve months to get back on track.  If so, we will end 2021 having added another $1 trillion to GDP.  



More Deficits = More Growth 




Federal budget deficits stimulate growth because the government injects more money into the economy (spends) than it removes (taxes).  Over the last 50 years, federal deficits have averaged around 3% of US GDP.  To offset the lockdowns, the US Government ran a fiscal deficit approaching 15% for 2020. Given the additional $900 billion stimulus recently passed, analysts now project a deficit of 10%.  However, with the Senate now in hand, Joe Biden may act on campaign promises and add even more stimulus, taking the deficit for 2021 back to 2020 levels.  If 2021 matches 2020 levels, the government will spend another $2 trillion above trend.       



More Money More Growth 





The policy array of the Federal Reserve essentially governs the amount of money (M2) in circulationPeriods of growthinduced inflation concerns (a la the mid 90s) lead the Fed to tighten money supply, while periods of recessioninduced deflation concerns (a la the late 2000s) lead the Fed to loosen money supply.  Take a hard look at the right hand of the chart above.  The Federal Reserve has grown money supply at an annual rate of around 6% over the last 40 years.  In 2020, the Federal Reserve grew the money supply 25%.  This means that $5 exists today for every $4 that existed at the end of 2019.  The Feds haven’t expanded money supply to that degree since WWII.  The chart below pairs the growth in money supply with growth in GDP dating back to 1831 






There is a clear historic relationship between the change in money supply and the change in GDP.  A 25% surge in money supply will create a surge in GDP should this 200-year relationship hold.



Have a great weekend!



David S. Waddell 
CEO, Chief Investment Strategist




Sources:  GFD, Deutsche Bank; FRED database; Peter G. Peterson Foundation (pgpf.org)


David Waddell
Author: CEO Chief Investment StrategistAfter graduating from the University of the South with a BA in Economics, David began his career with Charles Schwab & Co., Inc. in Phoenix, AZ. Having been recognized for his outstanding business development record, David was promoted to the San Francisco- based Institutional Strategic Accounts Team, which interfaced with the Big 5 accounting firms and Schwab’s largest customers. David left Schwab to continue his education at the graduate level in Boston. While earning his MBA degree with a concentration in finance and investments at the F.W. Olin School at Babson College, he was appointed by the college Trustees to manage a team of seven portfolio managers overseeing the student-managed portion of Babson’s endowment fund. David also founded the Babson Investment Management Association to assist undergraduate and graduate students with training and career path planning in the investment management field. As the firm’s Chief Investment Officer, David chairs the W&A investment committee and combines macro economic forecasting, macro market analysis and macro risk assessments to design portfolio strategies utilizing public market securities worldwide. A civic leader in Memphis, David currently acts as Chairman of Epicenter Memphis, and Co-Chair of the Memphis Chamber Chairman’s Circle while also serving as a board member for LaunchTN and the New Memphis Institute. David previously served as chairman for The Leadership Academy, the RISE Foundation, and the Economic Club of Memphis. He also chaired the capital campaign to build the “Live” stage at the Memphis Botanic Garden. David was a member of the 2004 Leadership Memphis class and has been recognized as one of Memphis’ “Top 40 under 40” by the Memphis Business Journal, and as a finalist for “Executive of the Year” in 2007. In addition to weekly columns in the Memphis Daily News and the Nashville Ledger, David has appeared in the Wall Street Journal, USA Today, Forbes, Business Week, Investment News, Institutional Investor News, The Tennessean and Memphis Business Journal. He has also made appearances on Fox Business News, Yahoo Finance, Bloomberg TV, CNBC, and CBS News and ABC News Channels. Read some of David's articles on his author page in Inside Memphis Business. David has two wonderful children, Easton and Saylor, an obedient Labradoodle named NASDAQ, and a devoted Goldendoodle named Ripley.


David S. Waddell


Chief Investment Strategist

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