Key macro charts update: still looking good

Consumer confidence is low, and surveys find that the majority of the US population thinks the economy is getting worse. According to Rasmussen, only 43% approve of the job Trump's doing. Gas prices are high—the other day I paid almost $7/gal—and there are widespread reports of consumers cutting back on non-essential goods and services. Reported inflation has jumped, and the market fully expects the Fed's next move will be to raise rates. Despite this grim backdrop, the stock market is making new highs almost daily (the S&P 500 is up 28% in the past year!), and corporate profits are simply fabulous. I can't remember another time with such a disconnect. 

It's time to review some important macro indicators:

Chart #1

Chart #1 shows that the M2 money supply continues to grow at a moderate pace—up just 5.1% in the past year, and in the past two years up a mere 4.3% annualized. Headline inflation has jumped, however, thanks to the complications of the Iran war which have sharply reduced the global supply of oil. If the Fed under new chair Kevin Warsh stands firm, higher prices for energy will not trigger a broad-based rise in prices. Meanwhile, the market has effectively tightened monetary policy by pushing 5-yr real interest rates up by 50 bps since the end of February, and by pricing in the near-certainty of a one quarter point tightening over the course of the next 12 months. 

From 1995 through 2019, the M2 measure of the money supply grew at a compound annual rate of 6%, a period characterized by relatively low and stable inflation. The money supply then exploded by some $6 trillion from 2020 through early 2022 as the federal government sent out Covid "stimulus" checks that—at first—sat idle in bank checking and savings accounts. As consumers and businesses regained confidence and the economy emerged from the Covid shock in early 2021, that extra M2 eventually became monetized, and that in turn provided the fuel for a sharp rise in inflation.

Today, M2 is only about 5% ($1.2 trillion) above where it likely would have been in the absence of the great Covid monetary shock. The Covid-related explosive increase in money has been absorbed by higher prices and a growing economy. Monetary policy has been back on track for several years now. This is key to the inflation outlook.

Chart #2

Chart #2 shows real (blue) and nominal (red) 5-yr Treasury yields, and the difference between the two (green) which is effectively the market's expectation for what the CPI will average over the next 5 years. Just before Covid hit in early 2020, inflation expectations were relatively low—about 1.6%. The Covid shutdowns at first caused inflation expectations to plunge to near-zero, then to soar to 3.7%. Today the bond market is priced to inflation averaging 2.54% over the next 5 years—only modestly above levels that the Fed should be prepared to tolerate. People may be worried about rising inflation, but not the bond market. 

Chart #3

Capital goods orders (Chart #3) are key to economic growth and prosperity, since new machinery, factories, and computers are what will drive future productivity. In inflation-adjusted terms, capital goods orders have been usually weak since the turn of the 21st century. Is it surprising that the economy has managed only moderate growth in the current business cycle which began in 2009. The recent strength in this series is a welcome breath of fresh air, and a sign that economic growth may continue to improve in the months and years ahead.

Chart #4

Chart #4 breaks down the Personal Consumption Deflator (the Fed's preferred measure of inflation) into its three major components. Things to note: since 1995, when China's economy started opening to the world and unleashing a flood of cheap electronics and appliances, the prices of durable goods have fallen by 30%. Meanwhile, service sector prices have risen by 141%, a direct result of rising real wages and a growing economy. Until the start of Iran hostilities, non-durable goods prices rose a bit less than 1% per year since mid-2022. Bottom line: outside of wages, and prior to the Iran war, inflation was largely confined to service sector prices, which in turn are largely determined by wages. These facts suggest that in the past 35 years, an hour's worth of wages now buys almost three and a half times more durable goods and 30% more nondurable goods. Wow.

Chart #5

Chart #5 is one of my favorite charts. The dotted green line reflects the growth trajectory of the US economy from 1965 through 2007, when the economy grew at a compound annual rate of about 3.1% per year. The dotted red line in the trajectory since the end of the Great Recession in mid-2009, when the growth trend abruptly slowed to 2.3% per year. If our economy had followed the 3.1% growth path, it would be 23% bigger today. The likely causes of this dramatic underperformance? Inefficient green energy subsidies, a huge increase in transfer payments, and increased tax and regulatory burdens figure at the top of my list. The recent strength in capital goods orders is the first indication that the economy may be regaining its former vitality.

Chart #6

Chart #6 shows corporate profits as a percent of nominal GDP. Think of this as a proxy for corporate profit margins: for every dollar of GDP, corporations today capture more than 11 cents of after-tax profits. That's  twice as much as during the 1970s and 1980s (as indicated by the dashed green lines). No wonder the stock market is making record highs! Corporate profits have never been so healthy. Wow.

Chart #7

Chart #7 shows the year over year change in the overall Consumer Price Index as compared to its ex-energy version. Energy has always been the most volatile component of the CPI, and today is no exception. The important thing here is that energy prices do not cause inflation. Monetary policy is the chief determinant. And as we have seen in prior charts, there is no sign that monetary policy has become inflationary. The ex-energy version of the CPI is up 2.8% in the past year, and that is only marginally higher than the 2.5% inflation expectations priced into the bond market. Bear in mind that this number continues to be artificially inflated by the flawed measure the BLS uses to calculate shelter costs. Nationwide housing prices are up by a mere 0.7% in the past year; on an inflation-adjusted basis, housing prices are down 3.7% from their peak in mid-2022. These facts have yet to be captured by the BLS, which uses the year over year change in housing prices from 18 months ago to compute shelter costs.

If you focus less on the headlines in the media and more on the underlying statistics, the picture becomes clear: the economy is in good shape and likely to get even better.

M2 update: still looking like inflation will remain low

Here's an updated look at key charts and indicators that I have been following for the past several years. All continue to suggest that inflation is likely to remain relatively low. Moreover, whereas the economic outlook had been looking rather modest, there are now welcome signs of an economic pickup on the horizon; this builds on the fact that corporate profits have been quite healthy of late. 

Chart #1

Chart #1 shows the growth of the M2 money supply, which is generally considered the best one to follow. For the past 3-4 years I've noted that the Covid-related "bulge" in M2 was disappearing, and that is still the case. The relationship between money and nominal GDP has almost returned to where it was pre-Covid. Recall that from 1995 through 2019 M2 grew at a 6% annual pace, while the CPI averaged about 2%. 

Chart #2

Chart #2 shows the 6-mo. annualized change in M2. Currently at 4.7%, it is still comfortably below 6% and shows no signs of any worrisome uptick. The Fed lost control of M2 from 2020 through 2021, but it has been back in control for the past several years.

Chart #3

Chart #3 illustrates what I call "money demand." It is the ratio of M2 to nominal GDP, and can be thought of as the amount of risk-free money and money equivalents that the average person or corporation wishes to hold, expressed as a percentage of annual income. Here we see that money demand is almost all the way back to its pre-Covid level. A powerful increase in money demand drove the ratio higher from 2020 to 2021, and an equally powerful decline in money demand (which in turn has been driven by a decline in risk aversion) has driven the decline in the ratio since 2022. Money demand appears to be stabilizing at a time that money supply is growing at a relatively slow pace. This argues strongly for there being an absence of any monetary source of rising inflation. Higher oil prices are certainly driving energy-related prices higher, but this is not symptomatic of an untoward rise in the general price level. I suspect that the longer oil prices remain elevated, the more stories we will hear of price declines in other areas of the economy. The economy's monetary "budget" does not allow for an overall increase in prices beyond what we have been seeing in recent years.

If anything, the war in Iran is more likely to increase the public's demand for the safety of money and money substitutes. In the absence of any acceleration in the supply of money, it is very hard to make the case that inflation overall is going to rise.

Chart #4

Chart #5

Capital goods orders are good evidence of corporations' willingness to invest in new plant and equipment (and software, aka artificial intelligence these days). Chart #4 uses a 3-mo. rolling average of monthly order levels for nominal and real values, whereas Chart #5 shows the actual monthly nominal values. Note how strongly orders have increased of late (Chart #5). This is big news, and strongly suggestive of a stronger economy in the years to come.

Chart #6

Not all is rosy, however. Chart #6 shows real and nominal nationwide housing prices (the index measures average prices in the three months leading up to the reporting period, so it is somewhat lagging the reality today). Real prices have been flat for several years, and nominal prices are up only 0.7% in the past year. This sure looks toppy to me.

Many millions of people own their homes, and these days they are paying a pretty penny to do so. One look at this chart tells you that home price appreciation has dropped to almost zero. Taking inflation and interest rates into account, owning a home is not only expensive (e.g., property tax, insurance, and mortgage interest) but also extremely burdensome. 

If you are paying over 6% to finance an asset that is not going up in price (and may soon go down), you are leveraged into a losing bet. Even if you have a 3% mortgage, the opportunity cost of money these days is closer to 5 or 6%. A "conservative" home purchase made with a 20% down payment and a 6.25% mortgage today equates to using 5-to-1 leverage. So the expected return today of owning or buying a house is approximately 6% less than what it is costing you, multiplied by a factor of 5 if you are using leverage to own it. If home prices stay flat for the next few years, you will be losing roughly 30% (6% times 5) of your down payment each year. (OK, for those who can deduct mortgage interest it's not quite so bad, but still ... and don't forget insurance—which has become extremely costly if unattainable for many—plus property taxes and maintenance.)

This is not a pretty picture.

Chart #7

Chart #7 shows the housing picture in a different light. Here we see that housing starts have been stagnant to somewhat lower for the past several years, and homebuilders are not very optimistic at all that things are going to get better. Plus, home sales have been very weak for years. Strong demand for housing coupled with a limited supply has forced prices higher, but that dynamic is running out of steam. Leverage worked to buyers' advantage from 2013 through 2021, but now the tables have turned. Things won't get better until mortgage rates decline meaningfully and/or home prices decline.

Chart #8

As Chart #8 reminds us, thanks to the BLS's method of calculating owners' equivalent rent, the OER contribution to the CPI is beginning to subtract from reported CPI inflation.

GDP update (4/30/26): the economy grew at a moderate 2.0% annualized rate in the first quarter. As the chart below shows, the economy has been growing at about a 2.3% annualized rate ever since the middle of 2009 (i.e., the end of the Great Recession). 

Chart #9

The green line is an extension of the trend that prevailed from the mid-60s through 2007. If the economy had followed that path, it would be 24% larger today. We've had 17 years of sub-par (by historical standards) growth. Let's hope that Trump's efforts to trim tax and regulatory burdens, coupled with the "magic" of Artificial Intelligence can boost our future growth path. 

Corporate profits are very healthy

Corporate profits are the mother's milk for equity prices, and they are stronger than ever relative to the size of the economy. No wonder the stock market has done so well in recent decades.

Chart #1

Chart #1 compares corporate profits (adjusted, and ex-Fed profits) to nominal GDP. According to the Q4/25 GDP estimates released today, corporate profits at the end of last year were up 8.4% from a year ago, and they totaled $3.6 trillion at an annualized pace.

Chart #2

Chart #2 shows the ratio of corporate profits to nominal GDP. As of the end of last year, profits were a record-setting 11.5% of GDP. Wow. Just Wow. And it's not just a recent phenomenon. As the chart also shows, relative to the size of the economy, profits in recent years have been running twice as strong as they were in the 80s and early 90s.

Chart #3

Chart #3 shows the long-term path of the S&P 500 index, as compared to an 8% annualized trend. When you add dividend yields of 1-2% per year, buying and holding stock in the country's 500 largest and most successful corporations has yielded about 10% per year since 1950.

Of course, there are times when returns have been far less than 10% per year, and far greater. If you bought stocks in October 2000, you wouldn't have broken even for almost 7 years. In contrast, buying stocks in April 2009 (at the bottom of the Great Financial Crisis) would have delivered annualized returns of almost 15% plus dividends. I was several months early when in November 2008 I argued that investing in stocks was the buying opportunity of a lifetime.

In any event, these three charts suggest that stocks today are neither very cheap nor very expensive from an historical perspective.