Gary Shilling
Wall Street Is in Denial Over the Economy
Everyone, from
corporate CEOs to investors, is too focused on the still decent nominal data
when the inflation-adjusted numbers tell a more dire story.
The
US economy is weaker than believed.
Photographer: Paul Yeung/Bloomberg via Getty
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By
September 2, 2022 at 11:00 AM GMT+1
Gary Shilling is president of A. Gary Shilling
& Co., a consultancy. He is author, most recently, of “The Age of
Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation,”
and he may have a stake in the areas he writes about. @agaryshilling
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We know
that the US economy is currently weak, but the real economy is really weak, and
the Federal Reserve’s commitment to precipitate a recession to curb high
inflation will make this reality obvious to seemingly oblivious investors.
Real gross domestic product dropped for two consecutive quarters,
and although the National Bureau of Economic Research has
yet to declare that a recession is underway, those who concentrate on nominal
numbers, uncorrected for high inflation, still hope that a business downturn
can be avoided. They talk about rising wages in a tight labor market with low
unemployment and job openings exceeding
the number unemployed. Hourly pay in nominal terms is up 8.8% since May
2021.
But corrected for inflation, real wages have declined every month since then, bringing the
cumulative drop to 3.2%. Even nominal wage growth is slipping, with March’s
annual growth rate of 5.6% slowing to 5.2% in July. When other sources of
personal income are included — employee benefits,
proprietor’s income, rents, interest, dividends and government benefits—and
income taxes are subtracted, disposable personal income rose 6.8% in the second
quarter from a year earlier but fell 0.6% when adjusted for inflation.
Falling Behind
Earnings have fallen all year after taking inflation into account
Sources: Bureau of Labor Statistics
Those who believe consumer
spending is robust are confusing the overlays of inflation for the real
economy. Since March 2021, nominal retail
sales have risen 6.9% but are down 4.1% in real terms.
Denial of the ravages of
inflation was also widespread in the late
1960s and 1970s when huge federal spending on the Vietnam War and Great
Society programs pushed the economy into double-digit inflation. Despite the
Johnson administration’s belief, the economy did not have the supply of labor
or the industrial capacity to produce both arsenals of guns (military outlays)
and butter (civilian products).
Corporate costs soared as
CEOs felt duty-bound to keep employees at least apace of soaring prices. So not
only did nominal wages grow but so did real pay. At the same time, depreciation
of plant and equipment, based on historic costs, fell far short of the funds
needed for replacement. Also, inflation created taxable inventory profits.
The dollar value of inventories jumped even though the physical size of stocks
didn’t change.
I pleaded with our
corporate clients at the time to look at their company results in real
terms to see just how much damage inflation inflicted. The universal response
was that Wall Street doesn’t care about real results so why should they? And
while the Dow Jones Industrial Average, in nominal terms, oscillated around the
1,000 level from the late 1960s to the late 1970s, in real terms it plunged
73.1% from January 1966 to July 1982.
Despite today’s high inflation, some stockholders are also in a
state of denial. On Aug. 16, Walmart Inc., the nation’s
largest retailer by volume, reported 8.4% revenue growth in the quarter
ended July 31 from a year earlier, less
than the 8.5% surge in the consumer price index. Grocery sales
volume at the retailer dropped during the quarter and operating income fell 6.8% amid higher discounts and selling more
thin-margin grocery items. Still, investors bid up Walmart shares 5.1%
the day of that announcement.
On August 23, Macy’s Inc., the biggest
US department store chain, cut its forecasts for
this year due to the economic downturn, the slowdown in consumer spending and
markdowns and promotions to get rid of excess inventories. Sales in stores that
were open at least a year fell 1.5% in its second quarter from a year earlier.
Still, shares of Macy’s closed 3.8% higher that day.
Today’s high inflation is
clearly eroding corporate results.
From the second quarter of 2021 through the second quarter of this year, gross
value-added of corporate business (in effect, corporate sales) rose 12.7%
nominally but just 5.1% in real terms. After-tax corporate profits did
worse, rising 7.4% but only 0.1% when corrected for inflation.
Inflation may have reached
its peak, but will no doubt recede slowly. So, the 5% increase in S&P 500
earnings that Wall Street analysts forecast for 2022, as reported by S&P
Global, will amount to a real decline. Investors, no doubt, will pierce the
veil of inflation and shift their emphasis to the growing weakness in real
corporate revenues and earnings. That, in part, may be behind the recent
renewed sell-off in equities. My earlier
forecast of a 40% total drop in the S&P 500 from the early January peak is
still relevant.
To contact the author of this story:
Gary Shilling at agshilling@bloomberg.net
To contact the editor responsible for this story:
Robert Burgess at bburgess@bloomberg.net
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