Trusting the system. Stocks raced to new highs yesterday in the wake of Wednesday’s disconcerting events. The healing has begun and investors are looking to a newly formed Congress to spend money.
N O T E W O R T H Y
The money hose. When it comes to forecasting growth, economists are often criticized for oversimplifying things. Think about how complex the US economy must be with more than 30 million businesses and 331 million people. Just think of how daunting it must be to tabulate the data, let alone forecast where it is going to be in the future. In, reality, it is not that complicated. Economists create what is known as an abstraction. That essentially means that they attempt to remove all of the many unimportant details and boil things down to the key drivers. According to modern economic theory, Gross Domestic Product, which is the sum total of all products and services in the economy, can be calculated in several ways, but the most common one is referred to as the expenditure model. That model assumes that everything created is consumed. Stay with me here, it will all come together. The theory breaks spending down into 4 basic components and is symbolized as follows:
GDP = C + I + G + NX
C = consumption
I = business investment / capital expenditures
G = government spending
NX = net exports
Let’s ignore NX for now to keep things at a high level. We all know that the Government spends lots of money. They have all of those fancy grey buildings in DC, filled with employees, computers, desks, and probably more typewriters than we would like to believe. There is also the military with all of those shiny jets, ships, and bombs. All of those things cost money and the total amount spent by the Government represents roughly 17% of total GDP. Next are those 30 million businesses I teased with at the top of the piece. Companies have buildings, factories, fixtures, vehicles, and probably not too many typewriters. The amount spent by those companies in capital expenditures represent roughly another 17% of GDP. That is referred to as private investment. In our abstracted model, that leaves 66% of GDP, which is due to… wait for it… CONSUMPTION. You know, consumer spending by everyday folks like you and me. Our spending represents 2/3 of the US economy! The more we spend, the greater the GDP. Consumption is determined by a) available funds and b) confidence. The more money we have, the more we can spend, and the more confident we are, the quicker we are to spend it. Government spending is determined by policy, a budget agreed upon by Congress and approved by the President. Business investment is a bit more complicated, but at a high level availability of capital and confidence are key drivers. So where are we after having the US Economy fall into a deep recession last year, and how do we get out of it… fast? Helping businesses stay afloat with loans, grants, and low interest rates enabling them to borrow money cheaply, is a good start. The Government can ramp up spending simply by deciding to spend more… how they do that is topic for much further discussion at a future date. Finally, consumers must be made confident, the unemployed must be supported until they can become employed, and finally… somehow, get some more money in their pockets. That is where the Government steps in. The Fed can lower rates, prop up financial markets, support the banking system, and make loans to businesses. The Government can simply increase their budget by building more roads, building more buildings, and hiring more employees. The Government can ease the financial blow of unemployment by extending benefits. Finally, the Government can also give consumers money… cold cash. If we look at the historical savings rate, it hovers around 7%. That means, in theory, consumers spend $0.93 of every dollar we earn… or get in a stimulus check. Remember that we, the consumers, make up roughly 66% of GDP. Democrats have made it clear that they would like to spend more on infrastructure and provide more direct stimulus to consumers. With control over both Congressional chambers and the White House, there is minimal political friction from stopping them. Markets applaud GDP growth. When it is expected to grow, stocks trade up, especially those that are most sensitive to economic cycles.
Stocks traded up yesterday hopeful that a now Democratic controlled DC will provide more stimulus. The S&P500 traded up by +1.48%, the Dow Jones Industrial Average rose by +0.69%, the Russell 2000 Index added +1.89%, and the Nasdaq Composite jumped by +2.56%. Bonds fell and 10-year treasury yields climbed by +4 basis points to 1.07%.
– Change in Nonfarm Payrolls (Dec) is expected to come in at +50k, down from last month’s +245k additions.
– Unemployment Rate (Dec) may have ticked up slightly to 6.8% from 6.7%.
– Next week, we will get JOLTS job openings, inflation figures, Fed Beige Book, Empire Manufacturing, Retail Sales, Industrial Production, and January’s preliminary University of Michigan Sentiment. Lots of potential market movers in the lineup, so check back on Monday for calendars and details.
– Fed Vice Chair Richard Clarida will speak today.
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