Do you know what the best thing about the ongoing “melt-up” in U.S. stocks is?
No? Well, let noted equities strategist Donald Trump explain it to you alongside Nobel Laureate Sean Hannity:
Now I know what you’re thinking and it’s the same thing Donald Trump is thinking: “the fake news media doesn’t talk much about how the stock market rally is rapidly reducing the national debt.” The reason no one is talking about that is because it’s not true and as Rex Tillerson will be happy to tell you if you get him drunk and no one is around, the President is a goddamn moron.
That said, the equity rally does benefit the economy even if the fabled “wealth effect” doesn’t operate with anywhere near the efficiency policymakers seemed to assume it does when they embarked on the greatest (or “worst” depending on your penchant for doomsday prophesying) monetary policy experiment the world has ever seen following the crisis.
On Wednesday, Goldman set out to quantify the effect of the rally on GDP growth in a note optimistically entitled “Wall Street And Main Street Intersect”.
This starts with the rally’s contribution to the continued loosening of financial conditions which, on Goldman’s measure, are the easiest since April 2000.
“We have argued that the most important reason for the acceleration in growth last year and for growth optimism in 2018 is the sharp positive swing in the impulse from financial conditions,” the bank writes, adding that “the run-up in the equity component of the FCI has accounted for roughly half of the 137bp index easing in 2017 and 80% of the of 32bp easing year-to-date.”
Ok, so as Goldman goes on to remind you, there’s some reverse causation going on when you start talking about equity prices and GDP growth. That is, higher stock prices are both a cause and an effect of better growth outcomes, so you have to control for that, and without getting into the details of the model, suffice to say Goldman tries.
Ultimately, they conclude that “equity prices are currently contributing nearly +0.6pp to real GDP growth, up from -0.25pp in early 2016, thus the stock market currently accounts for nearly two-thirds of the total +1pp growth impulse from financial conditions.”
That raises this question: ok, what would happen to that growth impulse were stocks to crash? Here’s Goldman’s attempt at an answer:
We first consider a sharp correction, where stock prices fall 20% in Q1 and stay flat afterwards, reminiscent of the 20% Black Monday crash in 1987. In this scenario, we estimate that the growth impulse from equity prices turns from a +0.6pp boost currently to a -0.5pp drag by early 2019 on a 4QMA basis, as shown in Exhibit 4. All other things equal, this bear market would still result in positive GDP growth in 2018 of 1.9% on a Q4/Q4 basis—significantly below our 2.6% baseline forecast—but have only a minor negative effect on growth in 2019.
One key bit there is “all other things equal”. It’s entirely fair to suggest that if we got another “Black Monday”, all other things would not in fact remain “equal”.
But taken at face value, what the above suggests is that if equities were indeed to correct by 20%, Trump’s growth “miracle” would look considerably less “miraculous”. Goldman also doesn’t attempt to posit what might cause such a correction, a key consideration for determining whether “other things” would indeed remain “equal”.
In any event, this is pretty interesting and because Trump loves to debate the interplay between the market and the real economy, we look forward to his take on Goldman’s latest which you can be sure he’ll discuss tomorrow on CNBC: