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This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article is by Richard Bernstein, macro portfolio manager and head of Richard Bernstein Advisors.
Each year, we highlight some of our favorite charts we think consensus is currently overlooking.
Profits, Not GDP Or Politics, Drive Stock Market
We approach the current environment by staying disciplined, slowing down the investment process and by staying dispassionate with respect to politics. Along those lines, our first two charts show U.S. real GDP and corporate profits through time.
There has been considerable hoopla about the strength of GDP growth during the second quarter, but U.S. real GDP growth remains within a slow-growth band that has existed since the bursting of the technology bubble in 2000.
Chart 1: US Real GDP
(QoQ % January 1946 – July 2018)
For a larger view, please click on the image above.
Source: Bloomberg Finance L.P.
Closer Look At Corporate Profits
Chart 2 helps explain why the U.S. bull market has been so powerful despite continued anemic GDP growth by highlighting corporate profits as a percent of GDP.
The corporate sector’s proportion of national income rose to all-time highs post-2010. This ratio has smartly rebounded, which has fueled the more recent leg of the bull market. Contrary to popular belief, the corporate sector (upon which the stock market ultimately focuses) has been historically healthy relative to the overall economy. The combination of tremendous liquidity provided by the Federal Reserve and a historically healthy corporate sector seems to justify both the length and magnitude of the nine-year bull market.
Chart 2: US Corporate Profits as a Percentage of GDP
(4Q 1947 – 1Q 2018)
Sources: Richard Bernstein Advisors LLC, BEA, Bloomberg Finance L.P.
Fixed Liabilities, Not Fixed Income, During Inflationary Periods
Data demonstrate that investors continue to focus on disinflationary asset classes and have yet to reorient portfolios toward assets that outperform during periods of accelerating inflation.
Unfortunately, inflation expectations troughed more than two years ago, and asset classes that benefit from accelerating nominal growth (stocks and commodities) have appreciated significantly, whereas broad fixed income has provided negative total return.
Chart 3 compares the returns of stocks, commodities and various popular fixed-income benchmarks since July 2016. The ongoing popularity of income-oriented investments shows investors have yet to understand the implications of higher potential inflation.
Household and corporate balance sheets constructed with general combinations of fixed asset values and floating liabilities tend to outperform during periods of disinflation/deflation. However, a combination of floating assets and fixed liabilities has proven more beneficial during periods of inflation.
Fixed income is unlikely to be a successful core holding if we are correct, and inflation continues to be higher than investors expect. Inflation is the kryptonite of income.
Chart 3: Stocks, Commodities & Fixed Income
(Total Returns July 2016 – July 2018)
For a larger view, please click on the image above.
Source: Bloomberg Finance L.P. For Index descriptors, see “Index Descriptions” at end of document
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