In The Bullring

US productivity is down, markets are down for the first time since June 2005 for five straight days (report). Then again, oil is down, sharply, and the Dow is hanging in there above that 12,000 threshold it reached last week and the Federal Reserve is still worried about inflation which means the economy must be growing. Most people are, understandably, walking around with question marks in their heads.

I pointed out a few days ago that productivity was unlikely to be up very much while private investment - which propells broader economic growth and hence inflation - was in the throws of massive expansion, because you don't get material produce - financial or industrial - until that private investment starts paying dividends in terms of earnings and produce. This is why GDP growth was down. Think of it from a personal point of view and it's easier to understand. If you start an online widget business and invest all the savings you have from last year's salary into that business, you don't get paid until either you a) earn something from selling some widgets online, or b) float your online widget company on the stock market and cash in some of your shares. That's productivity and GDP, and it's what's going on this year. It's also a very, very bullish sign for markets, which are all about earnings premiums, not current day scenarios.

To demonstrate this, I plotted some charts. This first one shows all the data from 1970 to present day of US private investment against US GDP growth (both nominal so no one like Daniel Gross over at Slate rehashes the cry me a river debate over nominal vs. real numbers):

There are several points of interest here. First of all, broadly speaking, look how the US has become a much more investment-heavy economy over the years. GDP growth having slowed is only natural, by the way, since it's the old law of 'it takes more to double 1 than to double 100'. The very fact that GDP growth even reaches levels of those thirty years ago says some bold things about the US economy. But most curiously, look how pre-1982 bull market and pre-1995 bull market GDP made a rapid decline as the private investment curve did the opposite and angled even steeper. This illustrates the point I'm making well; GDP declines rapidly if private investment goes up because there's not a lot being actually produced during that time. However, it comes back up a year to three years later, which is about the time all those private companies start paying out stock or dividends and selling some products. But most presciently of all, look how the curve on the private investment line has steepened up dramatically in the last few years. This, accompanied by short-term GDP growth decline, indicates a raging bull market is in the making. It's an EXACT replay of 1995 and 1981.

A scatterplot shows the correlations between the two sets of numbers:

There's a pretty solid negative correlation between GDP growth and private investment. What this means is that it's private investment which is negatively affecting GDP growth, just as discussed above. But what this scatterplot shows most revealingly of all is that this is particularly the case in bull markets, where the scatterplots are huddled together in a downward formation. The huddling effect we are seeing now - low GDP, steepening private investment curve - is the signal of good things to come in the market.

Not converted yet? Let's look at the Dow in terms of historical GDP growth and private investment:

The last two bull markets followed huge declines in GDP growth (the label should say GDP growth but it was late and I got lazy).

This is the Dow against private investment:

... and this one says it all. The Dow, which as I pointed out the other day with charts, leads the NASDAQ, is led by private investment growth: both of the last bull markets followed sharp increases in private investment. The action is actually a little more complicated than that, because private-stage investment and the markets are reflexive - mutually re-inforcing one another - after some time, but neverthless, the piggy bank start to swell first in private enterprise. What is truly alarming is how steep the PI curve has got, especially in correlation with GDP growth decline.

America needs to stop worrying about productivity, and start worrying about what to do with all the productivity when it comes about in the next three or so years, or it may find itself back in an enormous bubble. This is what happened in the late 1990's; productivity materialised, but was fed into productively non-existent assets, which killed the productivity cycle.

Either way, another bull market is coming.

Comments

[JustInTime]

While I too agree that another bull market is coming, I take slight issue with some of your graphics.

Comparing investment to GDP growth is not valid (IMHO) as you should either compare Investment growth to GDP growth or total growth to GDP.

Also, comparing Investment to the DOW seems a liitle pointless -- where else is that investment money going to go?

[Daniel M. Harrison]

JustInTime - Unfortunately, you're wrong. Comparing total private investment to GDP GROWTH is perfectly valid if what you're trying to guage is the effect of slowing GDP GROWTH (rather than a low overall GDP). Recent concerns about the economy focused on the growth of GDP being sluggish, not on negative GDP (which is a decline). These are quite different things.

Private Investment is not necessarily the only source of investment which should fuel a stock market - in many emerging economies bonds, foreign investment derived from overseas equity gains and salaries themselves contribute to the surge in markets. The remarkably exactcorrelation between the PI and Dow figures is notable for this reason: it's not being created by external 'shock' factors.