2026 Q1 Economic Update and Outlook

After a solid start to the year, stocks swooned in March, with the Vanguard Total Stock Maret Index fund (a good proxy for the entire US stock market) going from a positive year-to-date return of 2.4% in late January to -6.7% in late March. While a 9% negative return is common historically, in recent years such things are not supposed to happen.  Not to worry, investors quickly got used to $100 oil, or decided that it just didn’t matter or wouldn’t last, and stock prices rallied again.  From the end of the quarter to the date of this writing (June 4), the S&P 500 has returned about 15%.  

Damir Tokic calls the current market the “Mother of All Bubbles.”  This is due to what he describes as a “bubble in earnings”, with a historically high 42x Shiller Price/Earnings (P/E) ratio applied to these peak earnings.[1]  Two years ago, John Hussman wrote, “In general, if you want to make a lot of money, and you want to have a long bull market, you need high unemployment, depressed profit margins, and depressed P/Es. It’s beautiful double-counting. Multiplying depressed earnings by a low P/E is really double counting. Multiplying peak earnings by a high P/E, which is what we’re doing today, is also double jeopardy the other way. And the gap between peak P/E times peak profits all the way to trough P/E times trough profits, that’s a big run. That’s the kind of thing we saw ending up in 1974 and 1982, and to some extent in 2009. Yes, it was somewhat higher in 2009 than 1982, but the discount rate, interest rate, everything else had shifted, and it was down an awful lot from its peak.”[2]  In other words, your best performance follows the worst of times – when things have nowhere to go but up, and simply looking at the P/E is inadequate because the E is also cyclical.

Tokic argues that profits have been driven by globalization, fiscal and monetary expansion, and favorable demographics, all of which are now reversing.   To wit, in 2000, government debt was only 56% of GDP, but is now 125%.  The monetary base in 2000 was 4.2% of GDP, but is now 23%.[3]  While it is impossible to know the exact peaks, government debt/GDP over 100% is consider high, and the Fed’s balance sheet is a multiple of what it has historically been, making a continuation of the recent trends unlikely.  The demographics in 2000 favored continued spending and investment, with the Baby Boomer cohort 35-55 years old.  Today they are 60-80, which is an age when spending typically declines.

For a long time, I have been arguing that a major driver of increased corporate profits has been lower tax and interest rates.  Michael Solyansky, from the Federal Reserve, quantified this in a 2023 paper, “End of an era: The coming long-run slowdown in corporate profit growth and stock returns”.  He found that over 40% of the real growth in corporate profits from 1989-2019 was from lower interest expenses and lower taxes.  The percentage of Earnings Before Interest and Taxes (EBIT) going to interest and taxes dropped from 54% to 27% over that time period, allowing profits to grow 3.8% per year (nearly double the 1962-1989 rate) while EBIT grew only 2.2%, after adjusting for inflation.  In other words, much more of corporate earnings went to owners instead of creditors and Uncle Sam.  That’s been a great thing for investors, but not drivers we should count on permanently boosting growth.[4]

Continue reading here: 26Q1 Market Update.pdf

[1] (Tokic, 2026)

[2] (Hussman, 2024)

[3] (Tokic, 2026)

[4] (Smolyansky, 2023)