Are We There Yet?

We know that the markets are overpriced, but does that mean we are on the brink of a crash and burn?  In his Q1 letter from GMO, Jeremy Grantham gives his response to this question. 

He starts with the observation that the Fed is “bound and determined” to create another “full-fledged market bubble”.  It is hard to disagree.  Central banks of the developed world seem are caught on an unending treadmill of easy money.  They have little choice but to continue QE.

He then observes that the 21^st century Fed has a record of stimulating until it has created a bubble.  He cites the NASDAQ bubble of 2000, and the housing bubble of 2006.  It is hard to disagree, especially when the Fed has little choice but to repeat this pattern.

In Grantham’s estimation, bubble territory for the S&P 500 is around 2250, compared to around 2108 now.  He expects either a normal bear market soon, or a march to 2250 followed by a bigger disaster.  It seems prudent to forecast at least two scenarios but bold to call a specific top.  Of course, it is just one more analysis for consideration, based on one set of assumptions. 

What Grantham didn’t say is that people are catching on that central bank policies are not working.  After the housing crash, the economy came back, but only in a “new normal” way.  Disaster was averted at the cost of economic vitality.  Real wages are stagnant or falling, debt is climbing again.  Income distribution is more skewed than ever.  The economic fabric of America has been puffed up and hollowed out, and other advanced economies are in little better shape.

We are borrowing from the future to live today, rather than cutting back consumption to invest in the future.  Under these conditions, the markets are valued on policy promises, not on dollars and cents.  People are counting on the Fed to save the markets.

“It’s different this time” is not a sound foundation for investing.

The Fed pumped up the market, but how high can it pump valuations?  Without real growth, the advance just pushes PE multiples higher.  People are catching on.

What we are heading toward is a crisis of confidence.

Below Zero

Today's financial world is certainly strange.  The Fed Funds rate is nearly zero.  US Treasury bonds yield a little above zero.  Five-year German government bonds yield -0.07%. 

Now some conservative financial managers anticipate something similar – or worse – for future returns on US stocks and bonds.

The conservative asset management company GMO released its most recent forecast of anticipated future real returns for several different asset classes over a 7-year time horizon.  As of Jan 31, 2015, their 7-year forecast projects negative real returns for US stocks and bonds.  Even for emerging markets the estimated future returns are far below historical averages.

Of course, these are just estimates, which GMO accompanies by the usual caveats.  But they are not alone in taking a pessimistic view.  After several years of stock market gains and artificially low interest rates, it is not surprising that nearly every financial asset class in the world is overpriced.  There have been plenty of warnings from market observers.

Markets arrive at overpriced points like this in the normal course of events, every once in a while, but this time is hardly normal.  This time the situation is entirely artificial, the result of extreme fiscal and monetary policies intended to prop up the financial markets and the real economy.  After the 2008-2009 financial crisis, only extreme measures could stop the financial world from crashing and sending the world into a deep depression.  To many people who lost homes and jobs, it was a depression anyway.

The economy is not responding as well as wanted, and so the Fed has continued to levitate markets with QE, low interest rates, and other manipulations.

The crisis was a chain of failures caused by unreal expectations and extremes of leverage.  The Fed and regulators were supposed to prevent such extremes from recurring.  Instead, they have added fuel to the fire, and financial markets are more leveraged now than ever.

If something happens, the repercussions of a crisis could be greater than in 2008-09.

We don’t have to look far in today’s world to find escalating financial risks and potential triggers:  deflation, currency wars, soaring government debt-to-GDP ratios in the developed countries, failing economic growth.  It is just a matter of time.

I wrote about issues like this until two years ago and then figured “Why bother?  I’ve said it all before.”  But the problem is still here, and it’s getting worse.  I can’t foresee the future, but there are many reasons to believe that when the markets crack, it will not end well.

Candyland

Old favorites, the gumdrop trees.

International Human Rights Day

Yesterday, December 10, was International Human Rights Day, celebrating the 65^th anniversary of the Universal Declaration of Human Rights, signed in 1948 by the UN General Assembly.

Since that time, nearly all of the world’s developed nations have established social welfare programs ensuring that their citizens enjoy the fundamental necessities prescribed in Article 25 of the Declaration:

Everyone has the right to a standard of living adequate for the health and well-being of himself and of his family, including food, clothing, housing and medical care …

But that is not the case in the United States.  If you are a low income person in America, good luck finding adequate food, clothing, housing, and medical care. 

Medical care?  The Affordable Care act places basic health insurance within the budgets of millions more Americans, but it is far from universal medical care.  Of course, right wing extremists in Congress are laboring hard to undermine and reverse even the ACA and take that coverage away.

Housing?  HUD’s latest report estimates that 1.48 million people used a homeless shelter during 2012, but about a third of homeless people were not in shelters.  At least 1.1 million American children and youth were homeless for part of the 2011-2012 school year.

Food?  Even with present funding levels, it’s impossible for many families on food stamps to stretch their food budgets to last over an entire month.

Now, Republicans in the House of Representatives have been working hard for major reductions in the budget of the Supplemental Nutritional Assistance Program (SNAP), as part of their negotiations over the farm bill.  About four million people would suffer if Republicans succeed in cutting their goal of $40 billion from the budget over the next decade. 

Four in five SNAP families have incomes below the poverty line, and two in five have incomes less than half that much.  There will be no way for these families to make up the difference.

Health and well-being have much improved as standards of living have advanced since the adoption of the Universal Declaration, but let’s not forget that millions still lack these basic human rights.

Nelson Mandela, 1918-2013

A “Free Market” of the Rich and for the Rich

A recent post by Robert Reich (here) reminds us of the myths and lies used by the extreme right wing to justify reinterpretation of the “free market” in favor of their own, narrow interests.

Extremist Lies about the “Free Market”

Dr. Reich says:  “One of the most deceptive ideas continuously sounded by the Right (and its fathomless think tanks and media outlets) is that the “free market” is natural and inevitable, existing outside and beyond government.”  So, the extreme right says, keep government out of business. 

According to the revisionist lies of the Republican elitists, any attempt by the people to use government get the economy to work for them is wrong-headed and doomed to failure.  As Dr. Reich says: “According to this logic, government shouldn’t intrude through minimum wages, high taxes on top earners, public spending to get people back to work, regulations on business, or anything else, because the “free market” knows best.”

The Truth about the “Free Market”

Markets do not exist in and of themselves.  Laws, customs, skills, and infrastructure are all needed for markets to operate.  In fact, it is government that creates the conditions for markets to operate.  Dr. Reich provided a few examples of the issues that market rules address:

1. What can be owned and traded (the genome? slaves? nuclear materials? babies? votes?);
2. On what terms (equal access to the internet? the right to organize unions? corporate monopolies? the length of patent protections? );
3. Under what conditions (poisonous drugs? unsafe foods? deceptive Ponzi schemes? uninsured derivatives? dangerous workplaces?)
4. What’s private and what’s public (police? roads? clean air and clean water? healthcare? good schools? parks and playgrounds?);
5. How to pay for what (taxes, user fees, individual pricing?).

We the People Created the Market

As Reich points out, all of these rules are human creations.

We the people elect the government, and the government creates the conditions for the markets to operate.  Our representatives should set rules that benefit the nation in a broad sense by benefitting all of us, not just the rich and powerful special interests. 

It is not a matter of more or less government control of the markets.  We already have laws governing these kinds of issues, often to the exclusive benefit of the rich special interests served by the extreme right.

Don’t Let the Extremists Set the Rules

The right wing extremist lie about “free markets” is one of the biggest tools they use to shape the rules and regulations to favor their interests.  The right wing interests will do anything and utter any kind of lie to prevent us from creating market conditions that benefit the people.

We know the extreme right wing Republican Party for what it is – the same party that opposed scientific thought, racial equality, the rights of women, and anything else that did not aggrandize the controlling interests.  The party that uses bigotry, lies, and hatred to deflect criticism and maintain its control.

“Make the Economy Work for Us”

Markets without rules devolve into monopolies and abuses.  Maybe we have forgotten what our ancestors suffered through not long ago:  Child workers maimed by industrial equipment, consumers poisoned by contaminated foods, industrial workers enslaved by industrialists’ thugs and company police.  We are heading back in that direction.

We the people created the market, and it exists only to sustain us and our posterity.  If we fight the extremist lies and cruel policies that undermine the economic liberty of the great mass of Americans, perhaps we can achieve what Reich proposes and “make the economy work for us” -- an economy that works for all of us, and not just for the few on the extreme right who already control the wealth.