by Hubert Marleau, Market Economist, Palos Management
As a rule, the financial markets respond to macroeconomic forces like changes in employment, inflation and productivity, plus monetary forces like changes in the money supply and cost of capital. In a weird way, these get reflected in movements in nominal GDP in the form of business cycles and earnings performance.
The Commerce Department reported this week that the GDP in Q3 - the monetary value of all the goods and services produced across the US economy - rose at the blistering annualized pace of 8.2% - 4.3% real growth and 3.9% inflation - surpassing all expectations by a wide margin and well ahead of previous quarters, powered arithmetically by robust consumer spending on services, a large contraction in imports, vigorous investments in business equipment and intellectual property, plus government defence expenditures.
With job growth close to zero and aggregate hours worked in the private sector flat, productivity gains must have been huge, perhaps at an annual rate as high as 4.3%. As a result of this productivity boom, corporate profits in Q3 rose 4.2% q/q to $4095.7 billion for a quarterly increase of $166 billion, representing 27.2% of the overall increase in N-GDP of $609.4 billion.
Investors should take note that favourable credit spreads and supporting money supply increases were factors that allowed this productivity to take place. Over the past year, BAA-Bond yields averaged around 6.00% while money supply increased almost 5.0%, closely matching the year-over-year increase in N-GDP; and they still do.
Although the Q4 GDP figures will likely reflect drag from the shutdown, not to mention the faltering labour market, the Atlanta Fed’s NowCasting model has an estimated 3.0% annual growth rate, suggesting that productivity is still the main driver of the economy. Many economists believe that the economy has enough momentum to expand in 2026 for the fifth straight year, as does the Federal Reserve. In the words of the editorial board of the WSJ: “Trumponics boils down to a bet that the pro-growth impact of deregulation and tax reduction can offset the damage from tariffs, which are tax increases.”
Meanwhile, by every conceivable measure, Americans as a whole feel lousy about the economy, making the mood terrible. US consumer confidence plummeted in December, reaching a 12-month low of 89.1, with expectations and present gauges being now below the recession threshold for 11 months in a row. Yet the economy is red hot and doing just fine, because productivity has surged dramatically. Unfortunately, the early effect of productivity booms gets reflected firstly in corporate earnings before spreading broadly into labour income. This is why buoyant stock markets offer cold comfort to most of the population because the inequality of a bifurcated economy feels unjust. A good part of this has been caused by the regressive effect of tariff costs to consumers. Put simply, without tariffs, their personal disposable income would have kept up much better with the personal consumption expenditure price index. Imagine how well the economy would be doing without tariffs, says the WSJ.
What Happened in the Week Ended December 26:
On Monday, the S&P 500 rose for the third-straight day by 0.6% to 6878, kicking-off the Christmas holiday-shortened trading week in a festive mood as speculators and traders became increasingly confident about the year-end “Santa Claus Rally” with gold and silver in record territory.
On Tuesday, the latest batch of economic data released by the BEA showed that both inflation and growth had surged discouraging wagers that the Fed would keep cutting rates in the near term, with 10-year bond yields and the dollar index rising to 4.20% and 98.10 respectively, reflecting that the odds for a rate dip in January had dropped to a low of 16%, thereby suggesting that the economy does not need to change interest rates for several months. As the Cleveland Fed President Beth Hammock said: “My base case is that we can stay here for some period of time, until we get clearer evidence that is coming down to target or the employment side is weakening more materially.” Nevertheless, stocks managed to edge up weirdly, on very light trading volume, into record territory when the Conference Board confidence survey came below expectations, buttressing the fact that the Fed won't tighten monetary conditions any time soon. The S&P 500 ended the session at 6910, up 0.46%.
On Wednesday, stocks played it close to the vest, the S&P 500 nudging up 22 points to close at 6932.
The Near-Term Stock Market Outlook:
Last week I wrote: “TS Lombard’s chief economist Steven Blitz wrote a few days ago that the option market was predicting that there was as much as a 10% chance that the S&P could fall by as much as 30% in the coming year. That would clearly be ahead of schedule for this normally happens on average every 12.7 years. Moreover, this runs counterintuitively to the outlook for strong corporate earnings in 2026. Data compiled by Jefferies, a well-known investment banker, shows that the street expects 2026 will produce another year of double-digit earnings. This prediction would translate into 3 consecutive years of outstanding profit increases - a rare historical development. In the past 35 years, the S&P 500 posted this kind of earnings expansion only in 1993-1995 and 2003-2005 when productivity was as wild as it is now. What is even more exceptional is that both the buy and sell sides on the investment ledger have similar bullish profit numbers, Bloomberg Data Intelligence’ recent survey of analysts having revealed that S&P 500 earnings will rise 13%, 13% and 14% in 2025, 2026 and 2027 respectively.”
At this point, I have no reason to change my mind about the 2026 outlook for the stock market. However, cash levels are low (3.3% of AUM) - a contrarian indicator that suggests near-term volatility is likely.
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