It is quite commonly accepted on the street that monetary easing by central banks is responsible for much of the global markets’ success over the past year. Bond yields have been pushed to all time lows and so money managers have been forced to find yields elsewhere. Dividend yields on S&P exceed bond yields and so stocks have become the last performing asset class.
It’s been a year now since RBS came out with a report that indicated central banks around the globe were not only propping up markets indirectly with monetary easing but are actually directly investing into equity markets. Bank of Japan (backed by the same families backing the US Fed and the ECB) reported exactly one year ago today that it would be doubling its equity investments into 2014. It is an odd concept for an entity that can print money to invest into a market who’s value is determined by investors allocating finite resources. If infinite resources can be allocated well it’s not really allocating anymore is it? It simply becomes a Ponzi scheme. Interesting that S&P closed at record highs exactly one year later (yesterday).
Looking at the chart below (borrowed from Gurufocus.com) shows that we are in a bubble market relative to GDP in the US. Many top investors look to this metric as a leading indicator as to an overvalued market. However, I’m more interested in the idea that despite the overwhelming message from major media that all is well in America because the markets are at all time highs, the true economy is not moving in line. The suggestion that all is good because the market is at all times highs is simply wrong.
Further evidence is that M2 Money Velocity is at all time lows around 1.5X. Meaning money supplies are being used as ineffectively as we ever have to create income. Much of the reason is that corporate dividends have surpassed net investments as a percentage of GDP. The implication is that corporate profits are being sent to investors as dividends rather than being reinvested into capital and equipment to expand production (and thus jobs). This is supporting the widening income gap. And herein lies the spiral downward. Less jobs means a narrow distribution of income. Narrow income distribution leads to lower consumer demand. Lower consumer demand leads to lower private sector revenues (which we are seeing now). Lower revenues lead to cost side reductions, namely job cuts, in order to prop up profit margin. Bread winner job cuts force folks into low income work and thus the widening income gap. It also pushes many folks onto social assistance such as disability or other social welfare programs. Since 2008 food stamp recipients have almost doubled and disability recipients have increased 25%. This requires higher government expenditures yet relatively less taxpayers to fund those increased expenditures. This means more debt is required to fund expenditures. And so we see debt at all times highs of $17.56T, which is above GDP by more than $1.4T. And so we have come full circle to both an all time high stock market and debt levels. The key is where do we go from here?
Like businesses, households and markets, the economy can only lever up so high. There are only three things you can do with debt; 1. pay it off 2. roll it over 3. write if off. We’ve spent decades now rolling debt over while also increasing debt. We are currently monetizing up to 90% of our debt auctions and so rolling it over is becoming less viable as inflation is going to become a critical concern. We are left with paying it off or writing it off. Therefore the only solution that avoids an economic downfall is to create jobs and eventually pay down debt. The state of America’s future is wholly dependent on job creation. Period. The problem is that investors will likely choose to move capital to a new ‘host’ rather than attempting to resuscitate the current ailing host i.e. America. The future is grim if we stay this course.