The purpose of this article is to assess the relationship between the recovery time for the current stock market retracement and the strength of the private sector balance in each of the largest six countries by GDP.
The table below shows the list of countries by size of their GDP.
(Source: Trading Economics dot com)
The six largest countries by GDP is useful as it is where most stock market trading takes place and is of most interest to investors.
Among them, we have Western economies, Eastern economies, monetary currency sovereigns and also two euro countries (Germany and France) who are users of a currency issued by the European Union [EU].
A balance of sectoral flows model was used after the work of British economist Professor Wynne Godley to carry out the assessment.
In 1970, Professor Wynne Godley moved to Cambridge, where, with Francis Cripps, he founded the Cambridge Economic Policy Group [CEPG]. In early 1974 (after playing around with concepts devised in conversation with Nicky Kaldor and Robert Neild), Wynne Godley first apprehended the strategic importance of the accounting identity which says that, measured at current prices, the government's budget balance, less the current account balance, is equal, by definition, to the private sector balance.
Government spending [G] + Private sector spending [P] + Current Account Balance [X] = sums to 0 = GDP = GDI
By definition the stronger the private sector balance is, the stronger the private domestic economy and markets within it.
The table below shows the sectoral balances for the countries listed above.
(Source: Trading Economics dot com and author calculations based on same.
Very simply put, to arrive at the private sector balance one adds the net national government expenditure to the current account balance, the result by definition is the private sector balance.
If the result is positive, then the private domestic sector is growing in wealth. If the result is negative, then the private domestic sector is going into deficit (borrowing from banks) and running down its stock of wealth to balance the other two sectors.
This is an accounting identity and is correct by definition. There is no getting around or explaining the result away.
Stock Market Retrace Response
The stock market dip started worldwide in February 2018 and has been ongoing throughout the year.
America has the weakest sectoral flow at 1.93% of GDP. The chart shows that the stock market has yet to regain previous all-time highs and march into new territory.
The stock market has regained less than half its losses since February 2018.
The US stock market has not recovered well. Tax considerations have somewhat hampered the recovery. In April of each year, the private sector remits to the Federal Government its tax return and tax owed. This is a net outflow of money from the private sector to the Government sector and a reduction of the money supply.
Had the retracement happened at another time in the year this confluence of events may not have happened and the retracement not so prolonged.
The initial snapback rally through the end of February 2018 and into March was robust, reclaiming well over half the initial retracement losses, it was almost a "V" shaped recovery. Then came the tax payments and wiped that out.
In late May this year, the reverse occurs in that the Federal Government issues tax refunds to those that paid too much tax. This is discussed in more detail in this article.
China has the most robust private sector balance at over 19% thanks to massive government spending and investment on infrastructure projects.
The stock market fell as per the American market in February 2018 and has not recovered previous highs. In fact from a charting point of view, it has been making lower lows and lower highs
Japan has a relatively strong private sector flow of over 8% of GDP thanks to a combination of government spending and net export earnings.
The stock market has recovered strongly from the February 2018 retracement and is up over halfway to again reach former pre retracement highs.
Japan too had a midway low caused by national tax payment. If not withheld by the employer, national income taxes are due in full by March 15.
Germany has a relatively healthy private sector balance of over 7% of GDP thanks solely to its net export earnings. The government is a negative force in that it is running a surplus budget and removing euros from its economy.
The stock market has recovered strongly from the February 2018 retracement.
From a technical analysis point of view, it has made three lower monthly lows (not a sign of strength) and then after completing these three tests has gone on to make an almost complete recovery.
The German recovery was unaffected by adverse money supply flows as taxes are not due until after June.
The UK has the weakest private sectoral flow balance of minus 5.5% of GDP. This is thanks to both a large current account deficit and also a national government surplus budget. Both work to remove GBP out of the private domestic economy. The government surplus removes GBP completely out of existence.
The stock market response since the February 2018 retracement has been an almost complete recovery to the February start position. The best recovery of all the six listed countries in this assessment.
The deadlines for paying UK national taxes are in January and July which skirts the retracement phase nicely and has allowed a smooth and steady return to pre retracement levels.
France has a weak private sector balance of 2% of GDP.
The French stock market for its part has almost completely recovered from the February stock market retrace and stands with the UK as one of the best performers.
The chart pattern is one of three monthly test lows and then back up.
French national taxes are payable during 23 May to 6 June each year, so this retracement had no negative money supply flows working against it.
Logic would suggest that the countries with the strongest private sector balance would have the strongest markets. While the stock market is only one of many markets, one would have expected a correlation between a strong private sector balance and the stock market.
In the case of China, one can make an exception for the fact that its private sector flows are being invested mostly into its people and their infrastructure and not into paper assets such as common stock. Similarly, it is not as developed as the other countries in the sample, and most people in China do not have a tradition of or access to the stock market.
The other countries in the sample are all developed countries and at a similar level of development.
On the one hand we have Japan and Germany with strong private sector balances and on the other hand, the USA and UK and France with weak private sector balances.
Regarding the stock market retracement performance, the best performers have paradoxically been the UK and France even though their private sector balances are weak. The worst stock market performer of the developed nations overall is the USA, also with a weak private sector balance and a result that can be understood regarding that weakness.
The Longer-Term View
In the developed economies, and especially in the West, there is an austerity bias where the national government believes that low government spending and surplus budgets are best. Even though this leads to rundown healthcare and education services and infrastructure.
In the developed Western economies there has developed a system of inequality whereby the taxation systems are skewed in favor of business to the detriment of the poor. This means that a higher proportion of savings are spent into the stock market than might otherwise have been the case.
Similarly, less income is spent on real goods and services that might otherwise have been the case.
National income distribution and productivity have long parted company with the balance going to business owner earnings and profits as the chart below shows. Such people place their extra earnings in assets such as stocks, bonds, real estate and luxuries.
What this background means is that the stock markets in these countries are more likely to do disproportionately better than others because the level of inequality allow richer members of society to save more of their wealth in paper assets as opposed to productive ones.
How does this affect the long-term stock market performance?
The following table summarises the results.
(Source: Author calculations based on chart information from Investing.com)
A clear indication that austerity over the longer term does not improve stock market performance in a developed economy coming out of a recession.
The UK is by far the most austere of the developed economies and has also performed the worst.
The Chinese result shows that massive Keynesian style national government spending can also lift the stock market with it.
Here there is a correlation between the strength of the private sector balance and stock market performance. China leads and the UK comes last and the other countries array approximately in line with the relative strength of their private sector balance.
The lessons to be taken away are:
1. A stock market retracement recovery can be stopped in its tracks and prolonged if it coincides with a negative money flow event such as national tax payment time.
2. Over the longer term, austerity policies have a strongly negative impact on stock market performance. Not to mention disastrous societal outcomes.
3. Stronger private sector balance strength correlates with stronger stock markets gains over the same period.
4. Keynesian style national government fiscal policy produces a stronger stock market performance. Not to mention better societal outcomes.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.