As 2013 ends, how is the economy doing?
There are many ways to answer that question, but one the clearest is to compare employment, economic activity, and the market. Since the Financial Crisis, both the market and the economy have recovered and hit record levels, while employment is still below its 2007 peak. This gap—sometimes call the output gap—is a big source of concern for economists and analysts.
The economy is now producing $850 billion more in inflation-adjusted output with 2 million fewer workers than it had in 2007, so corporate profits are at record levels and over 40% higher than their pre-recession peak. This is a principal reason why the stock market has advanced so significantly, now 17% above its October 2007 record.
Why this is happening isn’t so complex, either. Capital is cheap; labor is expensive. The Fed has kept short-term rates below inflation since late 2008. Only now are they beginning to take baby-steps to normalize this situation, although many expect rates to remain low for a long, long time.
If the economy strengthens and unemployment falls, can profits stay this high or will they revert? That’s the 20 trillion dollar question—the size of the US stock market.