US stocks fell about 1% yesterday (give or take). Let’s see, the total value of the stocks trading on the NYSE is about $17 trillion. So, yesterday erased about $170 billion worth of ‘wealth.’ By our reckoning, there’s about $7 trillion left to go.
It’s too early to call a top… but we wouldn’t want to be sitting on the uppermost branch of this tree. The higher up you go, the more dangerous your perch.
From where we stand – on the ground and in plenty of cash and gold – the whole thing looks scary. There are too many people in that tree already… all of them counting on calm, sunny weather… and a longer growing season for their money.
What a shame it would be if the tree fell over… or a big branch snapped!
Everybody invests in stocks hoping to “beat the market.” But everyone IS the market. Only a few outliers beat it – usually by accident.
Of course, last year US stock buyers were happy just to ride along with the market. Beating it wasn’t necessary. As we reported, the rich saw their wealth rise by $3.7 trillion last year. Much of that came from the stock market, which hit new records.
Investors are hoping for a repeat of this performance in 2014. Even if it does half as well, they tell themselves, it will still be an impressive gain.
Real Wealth is in Decline
But we have some questions: Against whom are they gaining ground? From whom are they taking the loot? Or, to put it another way, who’s on the other side of the trade?
The US economy expanded at a rate of 2% in 2013. There was a grand total of about $340 billion in extra wealth to divvy up. How was it possible for shareholders to get 10 times as much as the value of the wealth the economy created?
But wait! The mystery deepens.
Since the depths of the financial crisis, household wealth has gone up by $21 trillion. (Roughly, it went from $50 trillion to $71 trillion.) During that same time, real household earnings for the typical family have gone down. Wages have gone down. And the net worth of the typical family also has gone down. Growth rates have declined. And, as a proportion of the population, the number of people with jobs has also declined.
Look at a chart of real GDP and you will see that it is only about 6% higher than it was in 2007. So, household wealth went up nearly 20 times faster than GDP since 2009.
How could that be?
Team Bernanke was trying to goose up asset prices. It succeeded. The “wealth effect” brought an additional $21 trillion to the nation’s balance sheets. This was supposed to increase demand, which would lead to more spending and investing.
Say’s Law tells us that you have to produce before you consume (more or less). But here we have about $20 trillion of excess spending power that seemed to come from nowhere. How could that be?
Wealth is either physical… as in owning a big house or a Modigliani. Or it is paper wealth. Now, we have new claims on $21 trillion of real output and real wealth. If there is no increase in real wealth, that money just competes for the same goods and services that were already priced at $50 trillion five years ago. We’re not a dime wealthier, in other words.
The Problem with Paper Assets
All paper assets are a claim against real goods and services. You can’t get more goods and services than the economy can produce. Since the economy of 2008-13 produced only a fraction as much real wealth as the claims against it, those claims will have to be applied to future output.
So, when will the economy produce $21 trillion of new wealth so that these new claims can be realized? Let’s see:
“[T]he future looks sluggish,” wrote Financial Times lead economist Martin Wolf. He joins Larry Summers, who argues that US growth is stuck in the mud… and may not get out any time soon.
“Since the start of this century,” writes Summers, “annual US gross domestic product growth has averaged less than 1.8%.”
Hmmm… that’s about $300 billion. Let’s see, how long do you have to wait – at $300 billion a year – to cover $21 trillion in claims? Answer: 70 years!
Well, that’s not going to happen, is it? Long before 2084 rolls around, those claims will be marked down and written off.
In other words, the additional wealth is mostly a mirage.
Is the Dow Due a Correction?
From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners
The rally in the Dow – and other US stock market benchmarks – is predicated on the continuance of the Fed’s EZ money policies (ZIRP and QE).
It is the stated intention of the Fed to produce something it calls the “wealth effect” by evaporating yields on bonds and therefore buoying up stock prices.
So far, this has been a success. Investors are certainly taking on more risk. They are shunning bonds and putting their money in stocks. Indexes are rising.
Our view is that earnings strength will eventually be needed to keep the rally going… otherwise, US stock bulls will come face to face with another Wile E. Coyote moment.
But on a technical basis, there’s no strong indication that the recent fall in the Dow is anything to worry about.
Our advice remains the same: Buy when others are fearful. Sell when others are greedy. Now is a good time to raise cash balances in your portfolio and wait for better buying opportunities down the road.