Despite the ongoing challenges, the global economy’s resilience has been intriguing and puzzling. Central to this resilience is a series of significant economic distortions driving the economy and the stock market. In this perilous environment, it is crucial to delve into these distortions and examine their origins, impacts, and potential implications for the 2024 outlook.
The Deficit Dilemma
One of the most significant distortions revolves around the federal budget deficit. According to data from the United States Treasury Department, 2023 deficit spending stands at an overwhelming $1.7 trillion.
Whether budget deficits stimulate the economy has been a contentious issue among economists, but in this case, the deficits appear to be stimulating the current economy. This is primarily because the deficit is largely driven by tax cuts and interest payments on debt, as opposed to a drop in tax receipts due to a weak economy. Federal revenue has been on the rise, even as deficits have simultaneously been increasing.
Government Spending And The Economy
The United States federal deficit spending is 6.8% of the gross domestic product. Only twice in history has deficit spending represented such a large percentage of total GDP: during the Great Financial Crisis and the COVID-19 pandemic. According to a Reuters report, the International Monetary Fund predicts the United States’ cyclically adjusted deficit spending will stay above 7% of GDP until 2028.
It is customary for government spending to increase considerably during severe economic shocks resulting in large temporary deficits. However, this is the first time government spending has remained so high amid a persistently strong economy. Federal spending programs related to the COVID-19 pandemic and new spending legislation like the CHIPS Act and Infrastructure Investment and Jobs Act are infusing significant capital into the private sector and helping to keep the economy running beyond capacity.
Government Hiring And Employment
Government hiring is a critical driver of the robust employment figures in the United States. The private sector and local, state, and federal governments have been steadily hiring since the COVID-19 crash in early 2020. “Employment in government increased by 51,000 in October and has returned to its pre-pandemic February 2020 level,” according to the Bureau of Labor Statistics’ summary of the October jobs report. The summary added, “In October, employment continued to trend up in local government (+38,000).”
With average monthly nonfarm payroll gains of 258,000 in the prior 12 months, it’s clear that employers across industries are fiercely competing for talent, driving wages higher in line with inflation. This dynamic is supporting household spending during a period of high inflation. However, according to data from the Atlanta Fed, wage growth is on a downward trend from its high of 6.7% in August 2022 to 5.2% in October 2023.
Housing Market Resilience
Despite the highest interest rates in over two decades, the housing market has demonstrated surprising resilience. Once again, distortions in the market due to the COVID-19 pandemic are responsible for this resilience. As part of its quantitative easing program, the Federal Reserve drove mortgage rates below 3% by purchasing mortgages to decrease long-term rates. This has created a unique distortion in the housing market.
According to Goldman Sachs, approximately 28% of mortgages are at or below 3%, effectively preventing homeowners from selling and suppressing inventory. This is because a new mortgage would be prohibitively expensive, with rates at 8% and housing prices virtually unchanged over the last year.
Despite a massive increase in interest rates to control inflation, an inverted yield curve, and most major reliable recession indicators flashing red, the United States economy has remained incredibly resilient. It is no coincidence that the economy has remained so strong amid highly unusual and, in many cases, unprecedented economic distortions brought about by massive fiscal and policy intervention in response to a once-in-a-century global pandemic.
Such massive fiscal interventions have caused equally massive economic distortions that will take time to move through the economy and financial system. While investors should remain cautious, the fiscal and government policies remain supportive, and like an oversized beach ball with a leak, it will take a while for the air to come out, but eventually, it will.
In the meantime, the trend in the market remains up, and investors should not get hung up on the why but instead make adjustments for the current reality. Full risk-on may not be the way, but there is risk in doing nothing when the economy shows Hulk-like resilience.
Investors should view this period as unique in economic history. The ongoing distortions in the economy and stock market underscore the need for investors to adapt to the new realities, considering the government’s increasing involvement and the significant shifts in fiscal and monetary policies.
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