Published – Idaho State Journal, 03/17/13
As the stock market has been advancing into all-time high
territory this week, many Americans are wondering how the economy can be so
great while they’re struggling so hard to make ends meet. Let’s correct that
perception immediately: the stock market is not the economy, and should not be
conflated with it. The stock market is only one of many indicators that measure
the financial health of the country. Wall Street, our metonym for the financial
markets, rarely resembles Main Street, U.S.A., and this market run provides a
perfect illustration of that fact.
The Dow Jones Industrial Average (DJIA), a composite of
stock prices of 30 of the top companies in the country, has been in record
territory for the past week. The Standard & Poor 500, an index comprised of
a broader selection of 500 of the largest companies representing all sectors of
the economy, closed Friday within five points of its closing record high. This
is encouraging to investors, until we consider that factoring in inflation, the
Dow is still about 1,500 points shy of its previous record in 2007. So while
the markets are high, the significance is not.
There are primarily three reasons the markets have ascended
to these lofty levels. The first is that after the market correction of 2008,
earnings projections were dramatically lowered in the wake of the reduced
economic growth prospects. The bar of expectations was lowered so far that they
had no place to go but up, and for the next eight quarters of earnings reports,
over 90% of publicly traded companies exceeded their reduced earnings
forecasts. Positive earnings represent profits, which is the fuel for
appreciating equity (stock) values.
The second reason is based on the cozy crony-capitalistic
relationship between Washington and Wall Street. With tax-advantaged treatment,
bailouts, grants, and interest-free loans, Washington has, for
self-aggrandizing purposes, infused massive amounts of capital into select
industries, sectors, and companies, that has significantly augmented their
financial condition.
The third, but arguably most significant reason, is Fed
monetary policy. Historically, the Federal Reserve, through their Federal Open
Market Committee (FOMC) has had two conventional tools at their disposal to
stimulate the economy, the Fed Funds Rate and the Discount Rate. The target Fed
Funds Rate is the rate at which banks and other depository institutions
actively trade balances held at the Federal Reserve, on an uncollateralized
basis. And the Discount Rate, or window, is the rate the Federal Reserve
charges member banks when borrowing money from the Feds for themselves, and not
for lending to other banks.
The lower these rates are, the cheaper money is to the
banking establishment, which at least theoretically, increases their lending
capacity, and lowers the prime rate to borrowers. The Prime Rate, which is
usually about 300 basis points (3%) above the discount rate, is the best rate
for banks’ best customers, and is what most other retail interest rates are
tied to.
The Fed Funds Target Rate has been at 0-.25% for the past
four years, as the FOMC has attempted to “jump-start” the economy after lapsing
into a deep recession in the fourth quarter of 2008. The affect has been
negligible. The leading indicators of economic activity continue to show
weakness.
Since near zero Fed Funds and Discount Rates have been ineffectual,
and governmental policy has been counterproductive in stimulating the economy,
including the much-hyped $800 billion “stimulus” spending, the Fed has had to
resort to an unconventional means of economic growth. Ben Bernanke borrowed a
book from the Japanese central bank to launch a process of Quantitative Easing;
this is a means of infusing money into the economy by the central bank buying
financial assets from commercial banks and other private institutions. Like the
rates that the Fed controls, this process is designed to increase liquidity
with lending institutions for new loans, using market forces to move long-term
rates lower on the yield curve.
Ben Bernanke’s Fed is now in their third iteration of
Quantitative Easing, referred to as QE3. The central bank is buying $45 billion
in Treasury securities (bonds and notes) as well as $40 billion in
mortgage-backed securities (MBS) every month, with newly minted cash from the
Treasury. By so doing, over $2 trillion in new cash has been injected into M1,
which accounts for all of the money in circulation, including coins, currency
and demand deposits, like checking and savings accounts.
Even this unconventional economic stimulus is inefficacious
to Main Street, the broader economy, but Wall Street loves it, as it has been
the primary mover of equity prices for the past four years. As the DJIA has
been steadily recovering since 2009, actual economic growth has virtually
stalled. Recently revised fourth quarter gross domestic product (GDP) figures
show the economy barely grew at an annualized rate of .01% last year. This is
not a healthy or expanding economy, especially when compared with China’s 7.5%
GDP growth rate.
“It really feels like this is what $8 trillion gets you,
between deficit spending and money printing,” said RC Peck, chief investment
strategist and CEO of Fearless Wealth. “It’s been about $8 trillion over the
last four years and I really don’t think we’d be at these prices [if it weren’t
for that].”
Bond manager Jeffrey Gundlach, CEO of DoubleLine Capital
concurs. Gundlach says, “The slow-growth U.S. economy is living on cheap money
as is the bull market, which is in its last stages.” He explains that the
central bank is committed to “easy money,” referring to the accommodative low
rate policy and quantitative easing. He calls these policies “circular
financing schemes.” He believes that the equity bull market is in its seventh
inning and when the game ends it will be “unpleasant.”
Those with 401(k)s are beneficiaries of the market run, as
are other private investors with stock holdings. But aside from that, ascending
stock prices have little impact on most Americans.
The economy has not improved in any tangible way for the
millions of Americans struggling with unemployment and underemployment. A
healthy jobs market is crucial to strengthening the middle class, which
currently exhibits a troubling lack of long-term stability. More people have
dropped out of the work force than at any other time, and median household
income continues to decline.
Lawrence Katz, an economics professor at Harvard said
recently, “You’re really struck by the unevenness of the recovery. The top end
took a whack in the recession, but they’ve gotten back on their feet. Everyone
else is still down for the count.”
The latest income figures from the Census Bureau confirm
this. “Median household income after inflation fell to $50,054, a level that
was 8 percent lower than in 2007, the year before the recession took hold.”
Just this week, the Federal Reserve announced a historic
shift in its primary focus. Previously, the central bank held to the conviction
that controlling inflation was their primary function, in order to stabilize
and grow the economy. They now believe that improving the labor market and
reducing unemployment is the key to economic recovery, growth, and stability,
and their tone in doing so has been with increasing urgency. Those of us who
work in the financial industry wonder why it took so long for them to realize
it.
The real unemployment rate, according to the Bureau of Labor
Statistics U-6, report, is 14.3%. And until that rate improves, which will have
to come in the form of fiscal and regulatory reform by Washington, not just by
Fed easy money policies, the middle class will continue to struggle, which
translates to reduced consumer spending and fewer durable goods orders, and
more small businesses strapped for cash as they compete for reduced spending
dollars. As it is currently, Wall Street is ascending, while Main Street
declines. When this bifurcation ends, it will be cause for celebration when the
markets reach new highs.
AP award winning columnist
Richard Larsen is President of Larsen Financial, a brokerage and financial
planning firm in Pocatello, Idaho, and is a graduate of Idaho State University
with a BA in Political Science and History and former member of the Idaho State
Journal Editorial Board. He can be
reached at rlarsenen@cableone.net.