late last month we went over the Atypical Behavior of Stock & Bond Market Discounts to try to explain why there was such divergence between equity prices that seemed to be discounting economic growth while the bond market seemed to be discounting economic deceleration.
the first conclusion was based on our theory that the risk-on/off trade had become inverted, something we now believe is in the process of unwinding. the second conclusion was based on the difference between the performance of the public economy which was contracting and the private economy which was expanding. The bond market was responding to the public economy contraction or actually the Fed attempt to fill the void while the stock market was responding to the improving private sector.
Nominal GDP = Private Consumption + Private Investment + Government Spending + Net Exports. While most economists and analysts focus on Private Consumption we wanted to focus on Private v Public spending. Here we show a chart of the breakdown showing Nominal GDP YOY growth v Nominal Public Spending/NGDP and Private Investment/NGDP. You can see that in 2006 no doubt surrounding the peak of the real estate market, Private Investment as a percent of NGDP collapsed to the lowest going back to 1972 (as far as I could measure) and with it went NGDP contracting by 3.9% YOY at the 2009 lows from the 6.5% pre recession clip.
Since the recovery, Public Spending/NGDP has now fallen as the Gov’t slashes expenditures due to the debt crisis, while Private Investment has rebounded nicely, though still below the 1992 low of around 13% . The lag in the topline NGDP number can be attributed to Public spending falling much faster than Private Investment increases.
It’s difficult to say if this rebound in Private Investment is sustainable but one thing is for sure, if these two components of NGDP are converging like they did during the 1990s, the real economy will begin to dominate the public sector. This is good for real growth and multiples which suggests that on balance you want exposure to US equities.