“The Stock Market goes up, up, up – will it ever come down?”
By Ty J. Young
We are in a bull market….there is no escaping that fact. I have argued, and many analysts have argued, that this can’t go on forever, that it is an artificial high. But at this time, there is no countervailing evidence to place against the record setting Dow and S&P. The S&P and Dow Jones have been reaching new highs on an almost daily basis. We have had short term retracements, specifically over the last few days, but nothing has seemed to stem the tide of bulls going over the wall of worry.
But what of the foundation for this stock market appreciation? What is it built upon? Never in my lifetime, nor can I find when scouring the history books, has so much of the performance of the stock market been determined by policy makers rather than free transactions between free actors in the marketplace. You can take a plane up 50,000 feet and no doubt can make the claim you have reached unprecedented heights, but when you run out of gas, the crash is no less deadly.
The one factor that has supported this growth in the stock market has been Federal Reserve accommodation, known in the vernacular as “money printing.” Our Federal Reserve banks’ dual mission is to combat inflation, and to combat unemployment, through bank policymaking. No one in the “old media” has provided an in-depth analysis of how this dual mandate can sometime’s conflict with one another, or how that may hurt the main street employee, but without question creating money out of thin air has consequences, none of which are good. Those consequences may not have impacted our daily lives yet, but they will. This may sound like the boy who cried wolf, you have heard this before. But the taxpayer is responsible for the federal reserve’s balance sheet. Combined with the national debt, state obligations, and the future costs of social welfare, most readers of my blog recognize the pickle we are in.
But back to the Federal Reserve. Printing digital money and feeding it into the banking system creates mal-investment, it artificially drives investment into areas either not necessarily in need of capital, thereby creating bubbles, or into sectors of the economy which should not receive additional investment (dying sectors or indebted institutions, etc.). The unstated purpose of all of this digital printing has been to inflate financial paper, asset classes related to banking and the stock market trade. This has made Wall Street just as wealthy, and just as insulated, from the real economy as right before the last crash in 2008. We are essentially creating new asset bubbles in the form of old asset bubbles. Real estate, for example, as well as the bank stocks, derivatives and credit default swaps which caused the market to collapse several years ago. When the Federal Reserve gives you free money, the bank will take it. When the Federal Reserve buys up mortgage backed securities, investors return to real estate. Not natural demand for a new home mind you, driven by employment and salary increases, just the investment community realizing they have a buyer for their mortgage paper.
There has been some benefit to this policy: for one, your mutual fund and stock portfolio as the basis for your retirement has been re-constituted, getting most people back to where they were right before the crash. Secondly, the rebound of the stock market, as a barometer of economic health, has given people a sense of stability, which in turn has loosened the consumer’s purse strings. Lastly, purchasing mortgage backed securities has most likely increased the value of your home (if you haven’t lost your home altogether).
Nonetheless, just because a policy has short-term benefit does not mean it is good for the society as whole; it does not mean that it is done with the public’s consent; and, it doesn’t mean that it has long-term benefits for society. You may want to buy a steak on Friday night, but the steak at the finest steakhouse in town is $200, and the steak at the local tavern is $30. You have $50. Do you borrow $150 to go to the finest restaurant, or do you stay within the budget and go to the local tavern? There is no doubt that the finest steakhouse in town should be the best experience, but how will you pay for it when the credit card bill comes due? Short-term policy making can, and usually does, have grave long-term consequences.
This is not just a deficit issue. Many people in the financial industry have little concern for the debt and deficit, and the lack of historical consequence for our current debt problem certainly supports their argument. When academics discuss the potential risk of default, or the debt squeezing out potential public services, I am reminded that historical references to countries who defaulted do not compare to the American experience. Our debt is denominated in our own currency, and trade partners use dollars for global trade, eliminating the risk of capital flight or an unbalanced influx of currency.
This gives us the unique circumstance to always be able to print our way out of debt. This was once referred to as our “exorbitant privilege,” a phrase coined by the French Minister of Finance in the 1960’s – Valéry Giscard d’Estaing.
But deficits and debt do crowd out investment. Cheap money (digitally printed money) does push capital into financial asset classes which create bubbles, as opposed to creative capital allocation or market driven capital allocation. Printed money does drive up interest rates. The Fed’s official rate may be at historic lows (although climbing) but you can see the inflated costs elsewhere – car loans, food, gas, and limited wage growth. I have mentioned before in other forms of media that Wall Street long ago was decoupled from the main street economy. Main Street long ago stopped benefitting from the deal making and financing Wall Street could offer – the investments made by institutional traders are predicated on policy making in Washington, not whether a company has a new project, a new drug, or new business plan that will create jobs and serve the interests of the consumer.
So what is the point of this blog? You have seen gains to your retirement accounts, many people are back to where they were or even with a little upside. But are you willing to go backwards again – something we have done several times during the 2000’s with two huge events setting our retirement planning back years (2001 and 2008). As you’ve heard me say – the world has changed, it is definitely not the 80’s and 90’s anymore. Is it not better to lock those gains in, and find a protected principal vehicle which will prevent losses during the next downturn? One immutable historical fact, the stock market goes up, and the stock market goes down. The only difference to those gyrations today is that Washington policy makers and global events have a greater effect than whether Hilton is a good company, or Merck comes out with a new drug. Should you trust Washington, and global events, to do well with your hard-earned money?
There are other options to placing your bets on DC. The smartest thing you can do is to protect your money against losses and there are 3 ways to do that: FDIC insurance, treasury bonds, and guaranteed insurance contracts (GIC). Most people gravitate to the GIC’s because they have the greatest rate of return – and can satisfy the most important concern you have for your savings – not losing it in the first place!