You are viewing Economy

There has been a historic intervention into the economy by the central government. Huge deficits were incurred. The U.S. Treasury and its partner, the Federal Reserve engaged in massive money-creation, buying (QE) all this debt. Essentially, the government loaned itself money; as much as it wanted and more. Interest rates collapsed to never seen before levels (0%). We were told this would find its way into the real economy and economic prosperity would return. So far, it has not. The financial sector and their cabal have benefited from this debt/financed binge of cash flowing to them but high unemployment remains and wages are downs. Trickle-down economics has yet to take hold this time. Clearly, the economic backdrop is not good.

Yet the U.S. Stock market is up. Reasons vary. Government deficit spending has replaced the tapped out consumer’s borrow & spend binge. This has maintained corporate revenues. Lower than low interest rates allowed corporations to refinance debt and add to earnings. The central banks newly created money has flowed into the stock market; boosting prices.

However, up is up. Although valuations are rich (link), especially given the economic backdrop, they may not be in bubble territory. Lazlo Birinyi still firmly holds that the time-proven rhythm of the U.S. stock market points up. And this is America. Great technological strides are being made; such as Apple’s harnessing and slick packaging of personal digital devices, Ford’s remarkable progress manufacturing fuel-efficient EcoBoost engines, the dramatic reduction of electricity used by LED lighting, or direction drilling reducing carbon emissions and making us energy independent to name a few.

Therefore, as we go into the Fall, U.S. growth stock funds are up about 16.0%, but emerging market funds are down about 13%, Intermediate-term bond funds are down about 4.0%, and money market funds pay next to nothing. This leaves a diversified portfolio up maybe about 6.0%. This is a respectable return, but not what the headlines lead the average investor to believe.

Now, all eyes are on what our government will do with interest rates (QE and its tapering) and how this grand experiment will end.

I have been writing, talking, and even ranting about duration, ultra-low interest rates, and the inevitability of higher rates and thus, lower bond prices (link). However, rates kept driving down to historic lows. But maybe it is finally time.

The interest rate on the 10-year Treasury rose off the bottom of 1.7% in May and broke through a 7-year trend line to 2.7%, as of this writing. Bonds prices dropped dramatically (link).

Our government needs to hold interest rates down to avoid the compounding effects of higher interest payments on the existing debt. In addition, our government needs to hold interest rates down until growth is strong enough for the economy to stand on its own. Their plan is to create new money, buy bonds, and keep interest rates low until the economy revives (Quantitative Easing). Inflation will then pick up along with higher wages. Deficits will subside due to higher taxes from a growing economy. Total debt will shrink in real terms due to controlled inflation, and interest rates will rise slowly. That is the plan.

They will do whatever it takes….which is to print money and buy bonds. The Fed simply cannot stop. Interest rates must stay down. But so far, little of this money has found its way past the stock market into wages. Hence, there is no growth. Their plan is not working.

GDP is growing at about an anemic 1.5% so far this year (link).

The July employment report confirms (as follows): link

I see no economic strength driving rates higher. The unemployment reports have not been positive. Full time, breadwinner jobs ($35,000+) are scarce and other employment measures are not good. The economy does not point to higher interest rates. The Fed has no reason to stop its Quantitative Easing maintenance of low interest rates.

However, the risk of principal loss has shown itself. Maybe something else is at play. Maybe with dividend yields so low, it is not worth the risk.

As always, it is not easy to see forward.