In the latter stage of the bull market culminating in 1929, the public acquired a completely different attitude to the investment merits of common stocks. Why did the investing public turn its attention from dividends, from asset values, and from average earnings, to transfer it almost exclusively to the earnings trend, i.e. to the changes in earnings expected in the future? The answer was, first, that the records of the past were proving an undependable guide to investment; and, second, that the rewards of offered by the future had become irresistibly alluring.
– Benjamin Graham & David L. Dodd, Security Analysis, 1934

There’s an old bit of advice that one shouldn’t count one’s chickens before they’re hatched. Much of the efforts of Wall Street are directed at ignoring that advice. That’s fine in the sense that prices can and often do move in advance of changes in economic activity and earnings.

Of course, Wall Street can also take its chicken-counting to extremes. Indeed, every speculative episode is based, in part, on extrapolating the addition and multiplication of chickens into the indefinite future. One of the most striking examples of excessive chicken-counting here is the way that Wall Street analysts and financial television anchors are equating the very reasonably expected post-pandemic “recovery” of private income and employment with an equally inevitable boom in real GDP, corporate earnings, and stock prices.

The problem with this is that nominal GDP is already at a record high, real GDP is within 1% of its pre-pandemic record, and S&P 500 earnings in the most recent three quarters already exceed S&P 500 earnings in the three quarters just before the pandemic. Meanwhile, the most reliable measures of S&P 500 valuation are easily beyond every prior historical extreme, including 1929 and 2000.

What’s going on is simple. Over the past 12 months, the U.S. federal government has run the deepest fiscal deficit since World War II. Investors seem to be vastly underestimating the extent to which a likely economic rebound will replace rather than augment the effect of trillions of dollars in pandemic relief programs, amounting to close to 20% of GDP, which preserved corporate revenues while subsidizing labor costs.

U.S. Federal deficit as a % of GDP

All of the fiscal support during the past year has held S&P 500 revenues within a few percent of record highs.