Monday, March 25, 2013
The Fed is Blowing Yet Another Stock Market Bubble
If the stock market's record run-up in the face of our continued economic weakness has left you bewildered, you're not crazy. Though the economy continues to struggle, Wall St. is thriving.
Since the second quarter of 2006, there have been only two quarters in which GDP was at least 4%. And over the last ten years, the average U.S. economic growth rate has been below 2 percent.
Inflation-adjusted wages fell 0.4% in 2012, following a 0.5% decline in 2011. Simply put, wages aren't keeping up with inflation. This is hurting demand and, ultimately, the greater economy.
Yet, despite all of this, the stock market is booming.
In the strange world of Wall St., the stock market thrives even as the economy remains anemic. Go figure.
The Dow Jones recently soared above 14,000, setting an all time high in the process. Yet, the Dow is simply an average of thirty large, publicly traded companies. Thirty companies in a sea of thousands do not accurately represent the vast U.S. economy.
The S&P 500 index recently began trading above 1,500 for the first time since December 12, 2007, just months before the implosion of big Wall St. banks sent the major averages crashing to decade lows.
Despite continual weakness in the economy and consumer spending (which accounts for about 70 percent of GDP), the stock market is booming. How can this be?
You can thank the Federal Reserve, which is pumping $85 billion per month of thin-air money into the markets. Quite simply, this bull market is being fueled by all the funny money being spun out of the Fed's printing press. Hundreds of billions in new money has been flowing into the stock market, which is pushing the averages to new highs.
This stock market run-up is nothing more than an illusion of economic well-being created by the Fed. It is entirely lacking in fundamentals.
The Fed is engaged in an aggressive bond-buying policy, in which it has been purchasing $85 billion in Treasuries and mortgage bonds each month in an attempt to lower long-term interest rates and spur the economy.
Before this year even began, the Fed had already expanded its balance sheet by nearly $3 trillion buying these assets in recent years.
Yet, the central bank is not finished. There are still hundreds of billions of these purchases to come and that money will continue to flow into equities, likely pushing the markets even higher.
At the current pace of $85 billion per month, the Fed's bond purchases will result in another trillion-plus dollars of freshly created money flowing into the financial and equities markets over the course of 2013. Such massive injections of liquidity into the economy have been, and will continue to be, quite favorable for equities.
This is why the market has been steadily increasing, despite the numerous factors arrayed against it — weak earnings, political tensions in Washington and a European recession. While this may seem incomprehensible, it is the result of massive sums of money flowing into the financial markets from quantitative easing. Wall St. has to send that money somewhere, and Treasury yields are at record lows.
Considering the historically low rates of return for Treasuries — which don't even keep up with inflation — it's easy to understand why all that money is instead flowing into the equities markets.
The biggest banks are getting enormous sums of money through the Federal Reserve as virtually zero interest. They are then able to invest hundreds of billions of essentially free money in the stock market and collect massive returns. This results in pure profit, which is one hell of a business model.
Though it's been widely reported that U.S. corporations are sitting on a record $2 trillion in cash, it may actually be as much as $5 trillion. Companies have been using some of that cash to buy up and reduce the total number of shares outstanding. Coupled with the roughly $2.8 billion in Fed money flowing into the financial markets every single day, there is an extraordinary amount of money chasing fewer shares.
So, the current stock market averages are quite misleading. They are simply a reflection of our continually irrational, bubble economics. Most critically, the vast majority of Americans are not benefiting from this stock market boom, which has seen the Dow jump 119 percent since bottoming in March 2009.
Unfortunately, the gains from this surging stock market have been flowing mainly to richer Americans. Roughly 80 percent of stocks are held by the richest 10 percent of households.
Quite predictably, middle-class Americans, having lost faith in the markets, sold their stocks over the past few years and have not benefitted from the rebound. During 2012, Americans dumped $204 billion in stocks, according to a report from the Federal Reserve.
Retail investors have been leaving the stock markets in droves for the past few years. In each of the last three years, individual investors have withdrawn more than $150 billion from U.S. stock mutual funds and ETFs. This means that millions of individual investors have missed the current market boom.
The truth is, the stock market is not an accurate measure of the health and strength of the economy. In reality, Wall St. is a pretty poor measure of the economy’s condition since it is simply a bet on the future performances of a select group of companies listed on a few stock exchanges.
Furthermore, as previously noted, the majority of Americans don’t have any direct investments in the stock market.
According to the June 2012 Fed survey, just 15.1% of American families had any stock holdings in 2010, down from a peak of 21.3% in the 2001 survey. And just 8.7% of families had direct ownership of pooled investment funds (mostly mutual funds) in 2010.
Clearly, the ballooning stock market is not a reflection of the financial well-being of the vast majority of Americans. Most of them aren't even investors. The markets are simply Wall Street's betting games.
Undoubtedly, the 2008 financial crash scared million of individual (or retail) investors out of the markets. However, even six years prior to the crash, more than four out of five U.S. households had no individual stock holdings.
In its 2002 study, the Mutual Fund Industry group, Investment Company Institute, found that only 21 million households (less than 20%) owned individual stocks outside an employee sponsored retirement plan. Employees in such plans are typically invested in mutual funds that give them no voting control.
So, Wall St. is not a true reflection of how the average American worker, or the average family, is faring.
Many U.S. corporations have been making money by cutting costs and laying off workers, not by increasing revenues. This increase in efficiency and productivity has resulted in corporate profits reaching all-time highs (as it turns out, workers who fear losing their jobs work longer and harder). And that's been putting even more downward pressure on jobs and wages, resulting in weaker economic growth and lingering recessionary effects.
So what's been good for U.S. corporations hasn't been good for American workers or their families.
And then there's the whole issue of Wall Street's manipulation and control of the equities markets.
By some estimates, "high frequency trading" is responsible for close to 70% of all volume in US markets. Computers can track hot stocks and immediately buy up all available shares. Since volume moves markets, massive purchases of millions of shares push prices higher, allowing computer algorithms to quickly sell those shares at higher prices. Millions of shares can also be dumped in just milli-seconds. That pushes share prices lower, allowing the computers to quickly swoop in and repurchase the shares at a lower price.
The radical, erratic movements of the stock market over many years can accurately be described as schizophrenic.
The markets are totally manipulated and, unfortunately, there will be a lot of losers because of this.
At the first sign that the Fed plans to withdraw its monumental levels of liquidity from the markets, they will go into free fall. Just the mere rumors or grumblings of the Fed's intention to change course could trigger panic selling.
Ultimately, this will not end well. It never does. We've seen the markets implode numerous times. The Fed's bond-buying program will conclude at some point. While individual investors, pension funds, mutual funds and the overall economy stand to lose big time, Wall St. traders will be the first ones to the exits, with their profits intact.
In fact, there is evidence that this exodus is already underway.
All bubbles eventually burst, and this one will be a whopper.