I – US growth, consumption and market valuation

At a time when stock markets seem to be weakened by European uncertainties and a series of bad US indicators, this paper seems particularly welcome.

Its problem shows show that a stock market reversal is likely in the US. It seems even inevitable at a time when the EDF is reducing its EQ operations to very little. The reader in a hurry will be able to go to the last chart which shows the close relationship between the operations of QE of the FED and the market valuation illustrated by the S & P 500.

The probable end of the QE program gives a particular importance to this paper. Indeed, it is not the improvement of the real employment situation that explains the stopping of the EDF’s QE policy, it is the risk – already fully present – of seeing the QE policy led to the formation of a stock market bubble whose bursting would be catastrophic. This exit of the QE is explained by the absence of effect of the reduction of the volume of purchase of securities (RMBS and Treasury bills) on the stock market valuation. The FED is, therefore, acting to put an end to an EQ program that has become dangerous because it has a speculative effect on the entire capital-money – especially its floating part – ready to engage in speculation.

It also follows that the Fed will have to quickly revise its interest rates on the rise, low-interest rates favor speculation by the leverage they induce. The stalling of the QE policy and the rumors surrounding the date of rising interest rates are therefore not positive signs.

The operations of the FED are therefore in no way the sign that the economic situation is really better in the US, it is only the ignorant to believe this nonsense, the situation of the US economy remains uncertain, fragile positive results and the exit of crisis always doubtful.

We start a series of papers on the consumption function in the USA.

Broadly understood consumption includes the purchase of goods and services and real estate investment; it accounts for nearly 75% of GDP.

We want to first examine the consumption of the top ten households. This consumption receives a boost from the valuation of financial assets that are very highly concentrated in their hands. The backbone of the valuation of these assets being the stock exchanges, it is primarily towards the stock market valuation that we must focus our attention. An upcoming post will deal with the movable valuation which is its counterpart.

This market valuation is fundamental in the consumption of the top ten; the valuation of the shares affects other financial products in the household wealth, we think in particular of mutual funds. This importance will be measured by referring to the Flows of Fund Account (ref).

As stock holdings are concentrated in the hands of the Top Ten more than 80%, stock market valuation involves the decision to consume rich and wealthy households, it also weighs heavily on households in the top quintile (Top 81-100 of percentiles) which accounts for 50% of the aggregate income of US households.

Stock market valuation is a multifaceted feature of US growth. The increasing valuation of shares encourages consumers to consume and reduce the savings of households in the top ten. GDP benefits from this consumerism. The speculative gains on the shares can give rise to value achievements after the sale of stock assets; the amount of these sales can be reinvested in financial products or spent. GDP benefits from this arbitrage, while taxes on capital gains enrich the state.

In the event of a reinvestment of capital gains on the sale of shares, the purchase of new shares is an additional income promise received in the form of a dividend. Immediate consumption of income can be favored by the promise of a growing accumulation of market values giving rise to increasing dividend amounts. The top ten can only be encouraged to consume.

With US income becoming increasingly polarized upward in the social pyramid, the state of the stock markets is therefore critical to the consumerism of the top ten and growth. Our review of statistical series also leads us to consider that since the millennium crisis, this imbalance of income to change the nature of crises. As the consumption of the top ten is the engine of American growth, recessions followed by a decline in the value of movable assets are rapidly affecting consumption, which is shrinking at the pace of asset value. This contraction of top ten consumption then has a recessionary effect on the rest of the economy, which in turn affects household consumption levels of low 90 or low 80.

On the other hand, the rise in the value of movable assets has a positive effect on the exit from the crisis.

The holder of the various forms of capital – productive, shareholder, interest-bearing – the income of the top Ten is recovering faster than the direct and indirect wage income. With highly paid wage positions, top ten employees are also less affected by wage cuts and unemployment. It is, therefore, the top ten that provides the first driver of recovery, the rest of the economy follows.

Stock market valuation is, therefore, an essential determinant of consumer spending decisions in the broad sense. A strong market valuation is, therefore, the condition for a rapid return to the consumerism of the top ten, consumerism to support growth. It is fundamental to rush this valuation to accelerate the recovery.

Our paper finds here its theme: the valuation of US stock markets has been extremely fast since the crisis: the S & P 500 index has thus increased from 808 in the T-1 2009 to 1946 today: the doubling is spectacular. It is, therefore, necessary to question the quality of this exceptionally fast and strong valuation.

Indeed, excessive valuation could be a serious obstacle on the road to “recovery”. One can even argue that a reversal of the stock market – resulting from an excessive valuation of shares – would result in a return of economic difficulties that the country is struggling to extricate itself.

Make no mistake: the stagnation of the real income of the low 80-90, a high level of real unemployment, real estate assets artificially inflated by the FED are all elements that weaken household demand. A stock market reversal could have in such conditions only very negative effects.

To judge the strength of the stock market valuation, we wanted to estimate the quality of this valuation which observers agree that it owes a lot to EDF QE since 2010.

We wanted to examine whether this valuation was justified or whether it was largely exaggerated. To do this, we took the broadest indicator of stock market dynamism: the S & P 500. We confronted it with the profits of anonymous US financial (Financial Corporate Business) and nonfinancial (Non-Financial Corporate Business) companies. Finally, we measured the impact of purchases of FED securities that provided liquidity to financial market participants.

We can thus measure the value of the US stock market, examine these relations to the real economy and estimate the merits of this valuation. It is not enough to say that the QE operations of the FED have had an impact on stock prices. It is also necessary to determine the weight of this impact which could play alongside other factors explaining the stock market variations.

Then becomes easy to make a judgment on this valuation and the risks – if any – that it can represent an exit from the crisis where the consumption of the top ten is so important.