Tomorrow is the big day.
Investors are on the edges of their seats, waiting to find out what the Fed will do.
Taper? No taper? Or maybe it will taper on the tapering off?
Our guess is the Fed will not commit to a serious program of reducing its support to the bond, equity and housing markets.
It’s too dangerous.
Ben Bernanke – the man who didn’t see the housing crash coming – won’t want to see the stock market collapse just before he leaves office. He’ll want to go out on a high note…
…and that means guaranteeing more liquidity.
Investors don’t seem worried. Yesterday, the Dow rose 130 points. Gold was up $10 an ounce.
Most of the reports we read tell us the economy is improving. Unemployment is going down. Meanwhile, manufacturing levels are rising.
Compared to Europe, the US is a powerhouse of growth and innovation, they say. Compared to emerging markets, it is a paragon of stability and confidence.
How much do investors love the US?
Let us count the ways:
1. GDP per capita is running 7% – ahead of where it was in 2007. Among the world’s major developed economies only Germany can boast of anything close. All the rest are falling behind.
2. The budget deficit – which was running at about 10% of GDP – is now down to just 4% of GDP.
3. Unemployment is going down, too. Heck, just 7 out of 100 Americans are officially jobless. Didn’t Bernanke say he would tighten up when it hit that level?
4. And look at prices. Consumer price inflation is running at just 1% over the last 12 months. No threat from inflation, either.
What if all these things were delusions… statistical folderol… or outright lies? What if the true measures of the economy were feeble and disappointing? What if the US economy was only barely stumbling and staggering along?
Well, dear reader, you surely expect us to tell that the US economy is a hidden disaster… and we won’t disappoint you.
GDP? Carmen Reinhart studied the performance of rich economies following a financial crisis. Her paper, “After the Fall,” showed that, six years after a crisis, per capita GDP was typically 1.5 percentage points lower than in the years before the crisis. But in the US, per capita GDP growth is running 2.1% lower than its pre-crisis level – significantly worse than average.
Deficits? Super-low interest rates have helped debtors everywhere. “Never have American companies brought a greater share of their sales to the bottom line,” writes Bill Gross. How did they do that? Largely by taking advantage of the Fed’s interest rate suppression program. But hey, the US government is the world’s biggest debtor. It is the primary beneficiary of the Fed’s miniscule rates.
That’s part of the reason why deficits are low. Let the yield on the 10-year T-bond return to a “normal” 5%, and we’ll see deficits soar again. (Interest payments, under this scenario, would add an additional $360 billion a year to the deficit.)
Besides, it’s not only the deficit that counts. It’s also the total level of debt… and particularly the debt financed with funny money from the Fed.
Only twice in US history has the ratio of US Treasurys held at the Fed gone over 10% – once in 1944 and again today. The first time, it was a national emergency: World War II. Now, the Fed is merely fighting to protect a credit bubble.
Inflation? Yes, consumer price inflation is low. But what that shows is that real demand is still in a deleveraging trough. The money multiplier – the ratio of money supply to the monetary base – collapsed in 2008. It has not come back. Neither has the economy.
Unemployment? The rate has been doctored by removing people from the labor pool. The workforce is now smaller – as a percentage of the eligible pool – than at any time since 1978.
Besides, what is important is not the rate, but what people get from employment. On that score, it is a catastrophe. According to a Brookings Institution study, the average man of working age earns 19% less in real (inflation adjusted) terms today than he did during the Carter administration!
A Strange Kind of Recovery
What kind of economy is it that reduces a man’s wages over a 43-year period?
We don’t know. But it’s not likely to win any prizes.
But why, with so many strikes against it, does the US economy still have the bat in its hands?
It’s partly because the Fed has pumped up stock, bond and house prices – not to mention net corporate profit margins (by reducing the interest expenses on corporate debt) and consumer spending (through entitlement programs funded through the Treasury with ultra-low interest rates). So, the averages look pretty good… and they mask the ugliness beneath them.
The rich got richer on the Fed’s EZ money. But the average “capita” is actually poorer.
The bottom 90% of the population – people in 9 houses out of 10 – have 10% less income than they had 10 years ago.
This is not a success story. It’s a disaster. And not one that tempts us into an overvalued US stock market.
P.S. This is also the conclusion of our investment team at Bonner & Partners Family Office,the family wealth advisory service we set up with our eldest son, Will. We’ve received a number of enquiries about how to get access to our research. We’re not accepting new membership applications right now. But Will is considering making some places available toDiary readers. So look out for more on that soon.
The Truth about Stocks and Economic Growth
From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners
It may surprise you… but investing in stocks based on GDP figures is a mug’s game.
First, GDP accounting is still rough around the edges. So, it’s hard to rely on the official figures.
Second, the positive correlation between and stock market returns and GDP growth is a phantom – despite being widely assumed, it does not exist.
Take a look at the chart below from investment firm GMO. It looks at real per capita GDP growth between 1900 and 2000 (horizontal axis) plotted against real equity returns (vertical axis).
…but that’s not the case.
What you see in the data set above is a negative correlation: Lower-growth countries have produced higher real equity returns.
One reason for this is something we hold dear at Bonner & Partners: the primacy of value. Put simply, the single biggest determinant of long-term returns is a low price relative to underlying value.
This helps explain the paradox of why high-growth countries produce lower equity returns than lower-growth countries.
Stocks in countries with high GDP growth tend to be priced at higher earnings multiples than countries with lower GDP growth. So, long-term returns are less impressive.
Our advice: Stick to the basics. As Ben Graham put it, “Endeavor to buy stocks when they are quoted below their fair value and to sell when they rise above such value.”
At above average 12-month trailing P/Es… and seriously above average Shiller P/Es… we see little value in US indexes right now.