Weekly Newsletter – January 26, 2024 – GDI Versus GDP

Over the past weekend, I went to the shopping mall - one of the most painful experiences that I have to endure, but I went in a supportive role for my wife!!!! As we walked (I was really being dragged), I noticed that many stores had huge discounts, and some were actually closed. I know it is January, but store closures, especially for larger chains, are a bad omen for the economy. However, the economic news that we hear on the news services does not support what I was seeing, so I thought that I better do more research. There are some real economic and market indicators that have a high correlation in predicting economic expansion and contraction – these are GDI in the US, the bond yield curve, LEI’s, and even the government’s own labour force. The data that is being used for today is all US, but the Canadian data is very similar.

GDP (Gross Domestic Product) is the most common method used to determine economic health, but GDI (Gross Domestic Income) may be a better indicator. In fact, Canada does not even use GDI as a measurement of economic health; we just use GDP. Essentially, they are very close in determining a country’s economic output – GDI is the sum of all wages, profits, interest earned, and taxes paid less net investment from foreign sources, while GDP is the value of all finished goods and services within a country. Historically, GDI and GDP mirror each other, but the current Real GDI (US) is only running at 1.5%, while Real GDP is running at 4.9% in the 3rd quarter of 2023, and now only 3.3% as of yesterday. This widening or divergence generally speaking has represented an economic downturn. Meanwhile, US LEI’s (leading economic indicators) have dropped precipitously since the end of 2021, indicating a recession, and the bond markets are still inverted. The bond market when inverted (meaning short-term rates are higher than long-term rates) has preceded every recession since 1930. I would say that is pretty accurate. By the way, the definition of a recession is 2 consecutive quarters of negative GDP growth, which already happened in the US in 2023, but for some magical reason, they decided not to declare that they were in a recession. And finally, when governments, in this case, the US, experience a hiring rate greater than 10%, it also signals a recession. The 2023 employment growth in the US federal government is 24.92% - crazy.

I am telling you all of this because the economic and market indicators are all flashing a recession while the business media continues to tell us all how rosy the world is currently. The business reporters are continuously speaking about 7 companies (Amazon, Alphabet, Nvidia, Netflix, Apple, Microsoft, Meta, and Tesla). Obviously, they are large companies, but there are so many more companies – the S&P 500 is called that for a reason. So back to reality. Let’s look at the major US indexes – the Dow and S&P 500. Both markets have been consolidating and are now flat since the late spring of 2022 – almost 2 years. How can it be that a few companies perform so well when the vast majority are basically flat over a 2-year period, and when will this situation change – or maybe it won’t? I argue that the change is close at hand.

As the inflation picture changes and interest rates decline, the markets will ascend. Capital Economics, a highly respected research company, has created a fabulous new report outlining various scenarios for different markets and asset classes globally. Unfortunately, Canada is not on the list, but if the US markets do well, so will our markets. Their outlook for equities versus all other asset classes, including cash, is bullish. If their forecasts are correct, then the total return on global equities from now until the end of 2025 will be close to 40%, with the US, Europe, and the UK leading the way. On the bearish front, the worst-performing sector is cash, which makes total sense. As we enter the next period of lower rates, valuations in the equity and bond markets will become more valuable while cash will become less valuable.