Is Economic Growth Hurting the Stock Market? No! The Enemy is Higher Interest Rates, Mr. President

Just last week President Trump tweeted that "In the old days when good news was reported the stock market would go up." He went on to say that today good news pushes the market down. He asserted this is a "big mistake." But is it?

Last week the U.S. Bureau of Labor Statistics reported that year-over-year wages advanced by a solid 2.9% compared to the post-recession growth of 2.2% or less. Good news for the worker and economy, but since that announcement all three major stock indices are down dramatically.

Instead of making a "big mistake," investors are simply assessing the likelihood of higher wages producing higher inflation, and then generating higher interest rates. Higher interest rates encourage investors to move funds from the equity, or stock market, to interest bearing accounts. If investors' fears are borne out and interest rates return to their post-2000 average, how much lower will equity markets likely fall?

Between 2000 and 2009, the ratio of the S&P stock index to corporate profits, as reported by the Bureau of Economic Analysis, was 10.6. However post-2009, the Federal Reserve's unprecedented monetary stimulus helped drive the rate on the 10-year U.S. Treasury to an average 2.44%, and the ratio of the S&P to corporate profits to 11.2.

Even after the recent market decline or correction, the ratio is still a high 11.6 on February 15. Thus, if rising inflation, the reversal of the Fed's post-recession stimuli, and the expanding federal deficit force the yield on the 10-year U.S. Treasury to its 2000-09 average of 4.48%, investors could see a decline in the S&P by 8.9%, other factors unchanged. This estimate assumes a 4.8% increase in corporate profits from Q1 of 2017 to Q1 of 2018.
Higher profit growth, and lower interest rate increases would mean a smaller fall in the S&P. On the other hand, lower profit growth and higher interest rate increases would mean a larger fall in the S&P.

The next key indicator to watch will be the wage growth number coming from the U.S. Bureau of Labor Statistics' jobs report on March 9. A year-over-year growth number above 3.0% will put a dent in the S&P stock index.

Ernie Goss