By Richard Bernstein, Richard Bernstein Advisors
It’s time for our annual August report, “Charts for the beach.” Each year we highlight five of our favorite charts we think consensus is currently overlooking.
Profits (not GDP or politics) drive the stock market.
At RBA, 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 US real GDP and corporate profits through time. There has been considerable hoopla about the strength of GDP growth during the second quarter, but US real GDP growth remains within a slow-growth band that has existed since the bursting of the Technology bubble in 2000 (See Chart 1).
CHART 1:
US Real GDP
(QoQ % Jan. 1946 – Jul. 2018)
Chart 2 helps explain why the US 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 an historically healthy corporate sector seems to justify both the length and magnitude of the 9-year bull market.
CHART 2
US Corporate Profits as a Percentage of GDP
(4Q 1947 – 1Q 2018)
We prefer fixed liabilities, not fixed income, during inflationary periods.
Data demonstrate that investors continue to focus on disinflationary asset classes and have yet to re-orient 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 and Fixed Income
(Total Returns Jul. 2016 – Jul. 2018)
Secular inflation?
We’re not wild about these types of charts, but Chart 4 compares the current cycle’s inflation with the secular period of inflation from the 60s and 70s. We are not showing this chart to suggest that inflation will follow a definitive pattern. Rather, we show it to demonstrate how benignly one of the worst inflationary periods in US history started. That might be worth considering simply because investors remain quite sanguine about inflation given the economic and policy backdrop. (http://www.rbadvisors.com/images/pdfs/
Overheating_Ahead.pdf).
CHART 4
Secular Inflation:
Feb. 1965 thru Mar. 1980 vs. Current
Quick history lesson
RBA believes that there could be considerably more inflation than investors currently expect, but we do not believe there will be secular stagflation. Nonetheless, it is a good history lesson to review what asset classes and sectors outperformed during the stagflation of the late-1970s (see Table 1 below).
To learn more about RBA’s disciplined approach to macro investing, please contact your local RBA representative.
www.rbadvisors.com/images/pdfs/Portfolio_Specialist_Map.pdf.
This article was written by Richard Bernstein, Chief Executive and Chief Investment Officer of Richard Bernstein Advisors, a participant in the ETF Strategist Channel.