- by New Deal democrat
As I type this, there are two particularly salient facts:
1. Although the US and Iran are not lobbing bombs at one another at the moment, the Strait of Hormuz is still closed.
2. The US stock market is, on an intraday basis, at record highs:
Huh?!?
On almost no level does this make any basic sense. There is no way that the global economy is as well off, let alone better off, than it was before the Iran war started. And if there was a peace deal today, it would likely be several months before the oil flow returned to normal — and likely a year or more before the Gulf States are able to repair all the damage to their oil and gas pumping facitilities.
Let me back up a little bit and see if I can discern what the stock market is smoking.
To begin with, yesterday’s PPI showed all YoY comparisons higher:
Total final demand PPI (light blue) was up 4.0% YoY; for goods (dark blue), the number was 4.1%. Even services (gold) were up 3.7%. And raw commodities (red) were higher by 6.0%. Since commodity prices feed through into finished goods, here is a historical look at the PPI for raw commodities, normed so that a 6.0% YoY increase shows at the 0 line:
On most occasions in the past, increases this much or more have been associated with supply shocks (1974, 1979, 1990, 2007, and 2021-22). With the exception of the last case, all such supply shocks resulted in recessions very quickly. But let’s take a look at the entire series to see why not every big increase in commodities resulted in recessions.
First, let’s compare the YoY% change in commodity prices with YoY real GDP (blue). I’ve divided up the past 80 years into two sections to better show the relationship:
In the 1950s as well as the 1970s oil shocks, a big increase in commodity prices of 6% or more YoY pretty quickly correlated with a decline in the growth of YoY real GDP. The same was true in 1988, 1990, 2001, 2004, 2005 (post-Katrina), 2007, and during the “Oil Choke Collar” period of 2011-12.
The only exception was during 2001-04 and the 2009-10 period immediately after the end of the Great Recession. The latter is explained by the fact that gas prices were at historic lows in early 2009. A surge in demand early in the recovery caused both real GDP and commodity prices to rise.
But 2002-03 stands out as the exception. Gas prices and other commodities rose in price, and real GDP accelerated. This was the quintessential “jobless recovery,” were jobs continued to be lost into the summer of 2003 due primarily to the “China shock” of manufacturing jobs being shipped overseas en masse. It was also the period when George W. Bush’s tax cuts kicked in.
Let’s do a similar exercise with corporate profits, since these ought to align more closely with stock prices:
Unsurprisingly, since corporate profits are a long leading indicator, typically they have led producer prices by one or several quarters, which is most apparent during the earlier slice of history above. Perhaps the biggest exception was during the Great Recession, when the two moved in opposite dirrections more or less in concert; but also during the earlier part of George W. Bush’s presidency, when they increased in tandem, again more or less simultaneously.
Now here is the current situation with real GDP:
Real GDP growth has been decelerating at a slow pace over the past serval years. And the current situation with corporate profits also shows a sharper deceleration in growth:
If the situation from the vast majority of similar episodes in the past holds true, both corporate profits and real GDP growth should slow further, if not turn absolutely negative.
So why are stock prices surging? Wall Street most likely thinks this is an episode like 2002-04, where lower tax rates (from last years Bust-out Budget Bill) together with AI holding down employment costs, more than overbalance the negative effects of the oil price shock.
In support of their position, let me offer the following graph of the last three years of YoY weekly retail spending from Redbook:
If anything, this shows that the top 10% of the income distribution has so pulled away from everybody else that even a financial shock administered to the bottom 90% is not enough to put a dent in the top tier’s spending.
