Okay, there’s a lot to talk about so I’m going to get right into it. The stock market continued to trade at all-time highs last weak amid more confusion and misinterpretation of recently released economic data. Yields took an unexpected 5% jump in the week while stocks stayed their over-valued course. See below.
The initial estimate for third quarter GDP was recently released and the growth rate came in way above what many economists had reasonably expected (2% growth). Instead, the first glimpse into 3rd quarter market activity showed a seemingly strong 2.8% growth rate. However, almost one-third of the total growth rate came from inventory buildups at store level, most likely in anticipation of the holiday season. The most telling piece of this economic news came from its most significant component: Consumers posted a modest 1.5% rise in spending for the quarter, a pace the Wall Street Journal describes as “torpid.”
Lethargic is my word.
Jobs data was also released which raised the unemployment rate to 7.3%. The most interesting caveat in this report was the labor participation rate, which is now at the lowest level in 35 years – way back to 1979 and the days of Jimmy Carter.
President Obama must be so proud.
The same economic diseases continue to infect much of the world. In a surprising move, the European Central Bank (ECB) cut its equivalent to the Federal Funds Rate to .25%, citing sluggish economic growth and persistently high unemployment to continue into the foreseeable future. The ECB had been trying to hold their main interest rate above the U.S. key rate (long been at .25%) to increase the value of the Euro against the U.S. dollar. The ECB made the move for the same reasons America did – with hopes that it will “stimulate” economic activity that would produce more jobs.
But America has long proven that this easy money formula doesn’t work. At best it facilitates higher national deficits, irresponsible sovereign debt levels, and an extremely inflated stock market.
Speaking of national debt, the U.S. Treasury announced plans to launch a new floating interest rate T-Note that will pay a higher interest rate as market rates rise – you know, should inflation suddenly appear and cause yields to rise. (But who’s expecting that?) The new variable rate T-Note is the Treasury’s first product introduction since 1997, and is set to hit the bond market early next year. The move, of course, is to spur investor demand for an ever increasing supply of U.S. government debt. It’ll be interesting to see how these yields play-out in the 2014 marketplace.
As mentioned in last week’s blog, quantitative easing (QE) fills the demand gap for U.S. government bonds that exists from free-market deficiency. This is to keep yields low.
The Fed prints new money to purchase new government debt using low economic output, high unemployment, and low price inflation as selling points to substantiate its QE policy. But inflation does exist, just take a look at the stock market, and economic growth and unemployment aren’t any better for it – while the fiscal position of the U.S. continues to deteriorate under pressure of greater annual deficits and larger national debt levels – all facilitated by the Fed’s easy money position.
Today, the Federal Reserve is doing exactly what Fannie Mae and Freddie Mac did during the subprime mortgage crisis! They encourage irresponsible lending by making debt and deficit too easy to obtain. Back then, Fannie and Freddie guaranteed any kind of mortgage paper, even bundles of notorious home-loan applications that included no income or employment verifications for borrowers. These guarantees dramatically increased the demand for high-risk subprime mortgages, which made it easy for Fannie and Freddie to issue more mortgage debt and guarantees than the market could reasonably afford. These government sponsored agencies, Fannie and Freddie, created a debt balloon that was unsustainable. And in the fall of 2008, that debt balloon burst and the inflated stock market corrected.
Just as Fannie and Freddie inflated housing market debt running up to the ’08 crash, the Federal Reserve is now inflating a national debt balloon by making it too easy for U.S. government to expand debt and deficit to unsustainable levels.
Of course, U.S government debt is backed by the full faith, credit, and net worth of the American taxpayer. Remember, the Federal Reserve purchases toxic assets from Wall Street banks with the QE money it prints. Much of the “toxic assets” are subprime mortgage paper created during the last financial debacle. The underlying asset to that paper, then and now, is U.S. land and American taxpayer dollars – because it is We the Taxpayers who are forced to bailout irresponsible borrowers, public and private.
National debt is simply a mortgage that if gone badly will leave American taxpayers on the hook to bail-out irresponsible borrowers (government) in dollars greatly devalued by central banks (Federal Reserve.) This is a wealth destroyer.
So in many ways this QE-boom is very similar to the previous housing-boom.
But as much as they are the same they’re polar opposites. Economic growth (especially consumer spending) during the housing-boom was robust; unemployment was low, inflation was tame, taxes were lower, and the national debt was somewhat reasonable.
So not the case in this QE era.
Another important distinction this time around is how much the dramatic increase in money supply is tied to low interest-rate government debt. When yields ultimately rise beyond these historic lows it will cause bond values to fall. Wall Street banks who are currently mandated to purchase U.S. Treasury debt with a portion of QE money will suffer huge losses under such a circumstance. This is, not to mention, that the U.S. dollar will also correct and fall in value at the same time of correction. And before you know it, banks will be in big trouble once again.
“Too big to fail” is alive and well.
Today’s condition is so reminiscent: another irrationally exuberant stock market during another subprime mortgage crisis destined for another ugly correction.
Fear not.
The easiest way to make money with investing, without a doubt, is by knowing where investments are in the current market cycle and taking appropriate actions to achieve your desired objectives. Below is a chart perspective that I haven’t shown for a while. It begins at the last “market bottom” way back in 2009 and extends through today.
The only thing hard to see in the chart above is the separation between Real and Nominal GDP, as both advanced 16% for the period, or 3% per year. “The market,” as indicated by the DJIA, more than doubled in the same timeframe, gaining 123%. Stock market strength via the 15-51i boldly added 221% in the period, and gold was up 40%.
In a nutshell, stocks are over-valued and gold is under-valued (as it is below “fair value”). Stock market strength is where it should be (above the Dow average) and the bottom for the next major correction, as I see it today, should be around 7,063.
Stick to your plan and make appropriate adjustments… and let me know if you need help.
Stay tuned…