November 24th, 2014
by Lance Roberts, StreetTalk Live
What You Already Know
The market rallied sharply on Friday on the back of announcements that China was cutting its overnight lending rate and Mario Draghi promising to buy more bonds if necessary to ensure the return of inflation.
Here is a question for you:
"Since stocks are supposed to be a reflection of economic growth, then why are stocks rallying on the back of news that clearly show deteriorating economic conditions?"
The reason that stocks are rallying is obvious: Liquidity.
What should be surprising is that despite globally low interest rates, massive liquidity by Central Banks and complete support for the banking system - inflation remains virtually non-existent. Such realities are not going to stop the Eurozone and Japan from doing more but therein lies Einstein's definition of insanity.
Meanwhile, back in the U.S., the Federal Reserve has stopped their latest rounds of bond buying and are now starting to discuss the immediacy of increasing interest rates. This, of course, is based on the "hopes" that the economy has started to grow organically as headline unemployment rates have fallen to just 5.9%. If such activity were real then both inflation and wage pressures should be rising - they are not.
The Dismal Economy
According to the Congressional Budget Office study that was just released, approximately 60 percent of all U.S. households get more in transfer payments from the government than they pay in taxes.
Roughly 70 percent of all government spending now goes toward dependence-creating programs. From 2009 through 2013, the U.S. government spent an astounding 3.7 trillion dollars on welfare programs. In fact, today, the percentage of the U.S. population that gets money from the federal government grew by an astounding 62 percent between 1988 and 2011.
Recent analysis of U.S. government numbers conducted by Terrence P. Jeffrey, shows that there are 86 million full-time private sector workers in the United States paying taxes to support the government, and nearly 148 million Americans that are receiving benefits from the government each month.
Yet Janet Yellen, and most other mainstream economists suggests that employment is booming in the U.S. Okay, if we assume that this is indeed the case then why, according to the Survey of Income and Program Participation conducted by the U.S. Census, are well over 100 million Americans are enrolled in at least one welfare program run by the federal government. Importantly, that figure does not even include Social Security or Medicare.
(Here are the numbers for Social Security, Medicaid and Medicare: More than 64 million are receiving Social Security benefits, more than 54 million Americans are enrolled in Medicare and more than 70 million Americans are enrolled in Medicaid.)
Furthermore, how do you explain the chart below.
With roughly 45% of the working age population sitting outside the labor force, it should not be surprising that the ratio of social welfare as a percentage of real, inflation-adjusted, disposable personal income is at the highest level EVER on record.
Currently, there are more individuals than ever before in history using student loans and disability claims to make ends meet. (Importantly, notice the spike in claims and loans immediately following the termination of 2-years of unemployment insurance.)
(No, Virginia, student loans are not being used for school. They are cheap and easy loans to get that are being used to for living.)
Here is the problem with disability. In 1968, there were 51 full-time workers for every American on disability. Today, there are just 13 full-time workers for every American on disability.
And while Obama is passing "executive amnesty" which will add another 5-million individuals to the economic fabric, it should be noted that according to a report from the Center for Immigration Studies, 43 percent of all immigrants that have been in the United States for at least 20 years are still on welfare.
While most economists continue to think that wage growth is just around the corner, it is hard to muster strong economic strength when most Americans are not earning enough to support themselves and their families without government assistance. The following are some statistics about wages in the U.S. from a Social Security Administration report that was recently released:
- 39 percent of American workers made less than $20,000 last year.
- 52 percent of American workers made less than $30,000 last year.
- 63 percent of American workers made less than $40,000 last year.
- 72 percent of American workers made less than $50,000 last year.
Despite the fact that 70% of exit polls in the recent mid-term election cited economic dissatisfaction, and a recent Gallup survey stated that "Unemployment/Jobs" represents the number one concern for U.S. voters, the mainstream media commentators continue to suggest that everything is just fine.
However, therein lies the answer as to why Central Banks globally are drowning the financial system with liquidity, suppressing interest rates and "jawboning" financial markets. The hope and prayer are that eventually a "fire" will ignite, and economic growth and inflation will return allowing for a gradual extraction of support.
The problem is there is scant evidence of any real success to date other than the inflation of assets back to dangerously high levels.
To The Moon Alice
As I noted in Friday's missive, Haywood Kelly penned a nice piece for Morning Star discussing the valuation of the markets. To wit:
"What is our valuation work telling us today? Our valuation lights are not quite flashing red, but they're not green, either. At best, they're signaling mediocre long-term returns for the stock market. Here's where we are as of this writing:
* The Vanguard S&P 500 ETF(VOO) trades just above our estimated fair value based on the valuation of its underlying holdings.
* As of Nov. 18, only 13 stocks out of 1,000 under coverage earn 5 stars, among the lowest percentages of highly rated stocks since we launched the Morningstar Rating for stocks in 2001. (At the market low in March 2009, we had more than 600 5-star stocks.)
* The highest-quality stocks (those with wide Morningstar Economic Moat Ratings) trade near the highest valuations we've seen since we began assigning moats back in 2002.
* Morningstar investment strategists uniformly believe it's difficult to find bargains today, a sentiment echoed by many of the best investment managers we talk to."
John Hussman, of Hussman Funds, also addressed the issue of the excessively overbought, valued and bullish conditions:
The chart below presents a slightly different perspective than similar charts I've presented over time. Rather than showing discrete instances where a whole syndrome of overvalued, overbought, overbullish conditions has occurred (points with bullish sentiment at extremes, valuations historically rich, prices pushing upper Bollinger bands, etc), the vertical bars show a count of individual components, coupled with additional components that reflect deteriorating market internals. This gives a less binary view of these syndromes. The spikes (such as 1929, 1972, 1998, 2000, 2007, 2011, and the past year) show points when a preponderance of conditions - extreme valuation, lopsided bullish sentiment, overbought conditions, widening credit spreads, and at least some aspects of deteriorating market internals - have been observed in unison. The red line shows the S&P 500 Index (log scale)."
4) Bull Markets Come AND Go by David Keohane via Fiancial Times
"As it currently stands, the current bull is the 4th longest out of 23 in terms of duration, 6th largest in terms of percentage change. It is well beyond both the mean and median based on this data set. There is no reason why the market cannot rally further, even becoming number one in either percentage or duration, or both, of being up on the year, this despite our 'circling the drain' feeling about this especially as the liquidity machine is still pumping in Japan, China and Europe. Given we agree with William Hamilton that the stock markets are 'soulless barometers'; the underlying bid suggests optimism in 2015. As long as the market views the Central Bank intravenous lines as a good thing, we respect the bullish trajectory.
But at some point out, the market will view the medicine as the poison. After all, consistently rising home prices were once also thought of as a good thing. Until the dramatic change. We remain vigilant."
The point here is that while markets are currently rising on promises of continued, and never ending, Central Bank interventions, it does not mean that eventually bad things will not happen.
It should be remembered that while it does "appear" that financial markets are in a bubble currently, this was also the case in 2000 and 2007. At market peaks, the calls are often for continued bull markets, new paradigms and a stretching of records. "Bubbles" are only seen in hindsight when the damage has been done. Of couse, you are supposed to find solice when you are told that "no one could have seen it coming."
The problem is that investments being made today are based upon a false doctrine. Valuations are not cheap, prices are stretched and leverage is high. Unfortunately, the only cure from the current misallocation of risk in portfolios will eventually be substantial losses.
Close To A Buy Signal
Now, having given you the bad long-term outlook, the good news is that in the short-to-intermediate term we are likely to get a "buying" opportunity to move allocations back up to full exposure.
The recent "spike" in the asset markets will likely take a pause following the Thanksgiving holiday as mutual funds distribute their capital gains and income for the year. Look for a pullback towards 2000 on the S&P 500 during this period to add to existing equity exposure and return portfolio models back to full weightings for now.
However, the markets are extremely overbought and, as shown at the bottom of the chart, the negative divergence in the indicator is a reason for some concern.
The current momentum in the market will likely carry asset prices higher into 2015, however, we will likely see a more significant correction in the early part of next year with the onset of a recession in late 2015 or early 2016.
Of course, getting the timing of events six-to-twelve months in the future is difficult. What I can tell you with absolutely one-hundred percent certainty is that a massive reversion to the mean lies ahead. This is why I watch the technical price indications so closely as it is only there will we find the "exit" sign.
If you are close to retirement - it would likely be wise to be tilted towards caution at this late stage of the market advance.
Have a great week and a Happy, and safe if you are traveling, Thanksgiving Holiday.
Disclaimer: All content in this newsletter, and on Streettalklive.com, is solely the view and opinion of Lance Roberts. Mr. Roberts is a member of STA Wealth Management; however, STA Wealth Management does not directly subscribe to, endorse or utilize the analysis provided in this newsletter or on Streettalklive.com in developing investment objectives or portfolios for its clients. Please read the full disclaimer at the bottom of this report.