New Era Economy and Financial Markets
by Victor Sperandeo with the Curmudgeon
The time-tested decades old
rules of buying and selling securities no longer apply. Risk control is a thing
of the past…. So are free markets. The
dumb money has become the smart money.
Many experienced money managers, that had made money in all (bull and
bear) markets, have had negative total returns the last 3 years (e.g. Paul
Tudor Jones). Two steep stock market
corrections ended mysteriously on October 3, 2011 and February 11, 2016 and
then began a straight up move without testing the lows or even basing. The 10-year T-note yield broke out above its
multi-year high (3.08%) this year, but then moved to a 25 bps
trading range instead of moving in the direction of the breakout. We could go on and on, but I think you get
the point: this time is REALLY different in both financial markets and the long,
slow economic recovery.
In this 2-part article, Victor and I will provide our perspective and insights on this “new era” and explain some of the root causes. Victor’s thesis is below. Mine will center on tech stock hegemony which has become a condensed version of the “nifty fifty” or “growth at any price” that prevailed in the early 1970s.
HOW DID THIS HAPPEN?
A sign that financial markets
are no longer free: Bear Markets are not allowed by the U.S. government, because that
might cause a severe recession resulting in elected officials being voted out
of office. Hence, loss of power must be avoided at all costs by those that run
Yet losses are part of
capitalism and free financial markets.
They teach lessons and are self-correcting. When loses are prohibited,
you have a political system based on Socialism.
The U.S. government, through
Federal Reserve Board policy manipulation, took over from free markets years
ago. For decades, bull and bear market
cycles were basically 3 years a bull, 1 year a bear. This was often associated with the 4 year “Presidential Cycle.”
That 4-year cycle was in effect from the middle of the 1800’s to 1987,
and to a lesser extent through 2008 (with the bear market delayed by one year
due to the financial crisis).
shows that from 1950 to 2004 (using the Standard and Poor’s 500 Index), the
most favorable period for investing was from October 1 of the second year of a
presidential term to December 31 of the fourth year. The remaining period—from
January 1 of the first year of the presidential term to September 30 of the
second year—was the least favorable period for stock market investors.
Also, markets could decline for many other reasons, but not now. After the October 1987 stock market crash, “Central Planning” took over. It has become the greatest existential threat to the US political system or a Constitutional Republic based on Liberty, since the US Constitution was ratified in 1789! Effectively, it has changed the US political system.
Alan Greenspan, an Ayn Rand (see pic and info below) acolyte of free markets and capitalism, became the Chairman of the Federal Reserve Board in the summer of 1987. He morphed into Dr. Jekyll and Mr. Hyde by promoting the largest ”Central Planning” experiment in US history. Greenspan was the founder of the “Presidential Working Group” (AKA the “Plunge Protection Team” or PPT). This group was formed to STOP steep stock market declines – mostly by buying futures on stock indexes like the S&P 500 (some say the PPT or its surrogates also buy stock index ETFs – like SPY, IWM, QQQ, etc.). If anyone did this except the Fed, it would be considered “stock market manipulation” and the culprit(s) would likely go to jail. Yet Greenspan became a God-like person on Wall Street and was dubbed “the Maestro.”
The belief that the PPT had put a floor under the market became known as the “Greenspan put” and later “the Fed put.” See: What is the Strike Price for the Fed Put?
This led to future Fed Chairman Bernanke and Chairwoman Yellen to take the Fed to manipulative concoctions never seen before in all of financial history. The excuse for doing this, offered by Bernanke, is called “the wealth effect.” It assumes that stock market gains make people feel richer, which leads to increase spending. The opposite is also part of the wealth effect – losses make people and companies feel poorer, such that they curtail spending.
Whatever happened to the old “Trickle Down Economics,” which was used as a derogatory negative slur, for a theory (?) that sounded like giving riches to the wealthy?
The Fed’s three HUGE rounds of QE’s and Operation Twist + zero interest rate policy (ZIRP) for 7 years (AKA “interest rate suppression) were a way of extending the economic recovery (from the “great recession”) and it significantly boosted both the stock and bond markets.
From 1854 to 2009, the average economic recovery was 38.7 months long, according to the NBER. However after the Maestro was anointed the average recovery length went to 95.4 months from 1982-date. This led to the classic indicators becoming worthless.
Short term interest rates at zero for 7 years led to ”Stock Buybacks” by major corporations- even when the stock price was historically high and had risen for years! Corporate America was also buoyed by the December 2017 GOP tax cut of 40% for corporations, but only 6% for the individual maximum rate.
Stock buybacks are an actual sign of company weakness, as profits are used to reduce the number of shares outstanding, which thereby artificially boosts EPS. It also reduces the overall supply of stock while boosting demand (the cash received from the stock buybacks is almost always reinvested in stocks). That’s instead of investing its capital to grow the company. While buybacks drive the price of the stock up, it is like saying: “We don’t know what to do to add earnings to the equity in the company, but we can raise the price of the shares.” This should actually create a lower P/E ratio, as the company refuses to grow its total earnings. Also, inflation will reduce the value of those stagnant earnings. Hence, total real earnings are less with stock buybacks then if the companies had invested in additional plant, equipment, or employees or other capital.
Let’s now look at how inflation is manipulated. The Fed targets inflation at 2%? Wonder why Its 2%? The key is how do you measure the 2%? The CPI is currently 2.8% YoY. But the Fed uses PCE or “personnel consumption expenditures” as its inflation gauge/metric. The PCE Index measures price changes in consumer goods and services. PCE is almost always lower than CPI. For example, over the last 12 months, the core PCE (x-Food and Energy) rose at 1.8% through April 2018, while the all items CPI rose 2.8% before seasonal adjustment through May 2018.
Also, the CPI is manipulated to be lower, so that real GDP looks stronger than it actually is. Also, the social security cost of living index is based on the CPI which is lower than it should be, thereby saving the government from paying social security recipients the true cost of living adjustment.
A further mystery of manipulation is in the unemployment numbers. The unemployment rate is currently 3.8%, yet wages are barely rising? Why, with reported seasonally adjusted (SA) non-farm workers averaging +207,000 a month in 2018 (through May). Yet “Not Seasonally Adjusted” (NSA) workers average only +155,000 a month. But wait….BLS also adjusts the NSA payrolls to the (miscalculated) Birth/Death (B/D) model, which are ”estimates” of new business less closing businesses that are not counted ,but estimated through past models designed in the early 1980’s.
Estimated B/D workers average 93,000 a month, that should be deducted from the ”real” NSA numbers, and what you get is a +62,000 average jobs a month in 2018. That’s quite a bit less than the reported SA non-farm payroll monthly increase of +207,000!
àThis is my reason why wages are not rising: the real increase in average monthly non-farm payrolls is much less than the US government reports! The employment numbers, like all other government statistics, are fixed to show “Anything ...the BLS damn well pleases! “
In summary, the economy and financial markets are manipulated to the extremes of history.
Let’s end with the sentiments of the woman who taught Greenspan about reality. The situation of corruption in government from head to toe was best described by Ayn Rand in her novel The Fountainhead: “The hardest thing to explain is the glaringly evident, which everybody has decided not to see. “
Ayn Rand’s first real success was The Fountainhead (rejected by more than ten publishers before publication in 1943). She started a new philosophy known as Objectivism, opposed to state interference of all kinds, and her follow-up novel Atlas Shrugged (1957) describes a group who attempt to escape America's conspiracy of mediocrity. Objectivism has been an influence on various other movements such as Libertarianism, and Rand's vocal support for Laissez-faire Capitalism and the free market has earned her a distinct spot among American philosophers, and philosophers in general.
Good luck and till next time……
Follow the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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