The Great Disconnect Revisited; ACA Impact on the Economy and Equities

by Victor Sperandeo and The Curmudgeon


No one can any longer deny a total disconnect between the slow growth economy and soaring equity values (especially small caps) in the U.S. and in most of the world.

The U.S. stock market is already way overpriced, margin debt makes new highs every month, corporate profit growth continues to decline.  Yet we see new all-time highs for equities almost every day or week.  Reason:  Fed continues QE with no taper in sight, so "greater fools" prevail.

In France, the CAC 40 stock index is at a new all-time high, yet the economic numbers (growth, unemployment, corporate profits, etc.) are terrible. The avowed Socialist President- François Hollande -has only a 15% approval rating.  That's much lower than President Obama current 39%-42% approval. But their stock market keeps going up, nonetheless.

ECB Bank President Mario Draghi says he'll "do whatever it takes" for the Euro based economy to survive and prosper.  He is effectively saying "buy stocks, because we're placing a floor on downside risk" (i.e. that's equivalent to a "Draghi put").


Relevant Historical Quotes:


This incredible quote by Sir Josiah Stamp may be enlightening, especially when compared to speeches by Central Bank heads Ben Bernanke, (future) Janet Yellen and Mario Draghi:  

"The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented. Banking was conceived in inequity and born in sin . . . . Bankers own the earth. Take it away from them but leave them the power to create money, and, with a flick of a pen, they will create enough money to buy it back again. . . . Take this great power away from them and all great fortunes like mine will disappear, for then this would be a better and happier world to live in. . . . But, if you want to continue to be the slaves of bankers and pay the cost of your own slavery, then let bankers continue to create money and control credit. [Web of Debt, p. 2]" 


Note: Sir Josiah Stamp was a director of the Bank of England, beginning in 1928, according to Wikipedia. Ellen Brown attributes this statement to him. It is from a speech delivered in 1927.


The above honest exposé, along with the Rothschild's view of controlling money as the end all, seems to be quite relevant today.  Mayer Amschel Rothschild (1744-1812), founder of the House of Rothschild, wrote: "Let me issue and control a nation's money and I care not who writes the laws."  


The words of Woodrow Wilson are also applicable: "A great industrial nation is controlled by its system of credit. Our system of credit is privately concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men ... We have come to be one of the worst ruled, one of the most completely controlled and dominated, governments in the civilized world—no longer a government by free opinion, no longer a government by conviction and the vote of the majority, but a government by the opinion and the duress of small groups of dominant men."


"Since I entered politics, I have chiefly had men's views confided to me privately. Some of the biggest men in the United States, in the field of commerce and manufacture, are afraid of somebody, are afraid of something. They know that there is a power somewhere so organized, so subtle, so watchful, so interlocked, so complete, so pervasive, that they had better not speak above their breath when they speak in condemnation of it."


All of the above is from Woodrow Wilson's, The New Freedom: A Call for the Emancipation of the Generous Energies of a People (New York and Garden City: Doubleday, Page & Company, 1913).  It's ironic that former President Woodrow Wilson was the man who signed the Federal Reserve Act of 1913 into law.   A decade after he signed the Fed into law, Wilson wrote:

"I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated Governments in the civilized world — no longer a Government by free opinion, no longer a Government by conviction and the vote of the majority, but a Government by the opinion and duress of a small group of dominant men."

Fed Monetary Policy Impact on Corporate America:

The Fed's money printing mentality has scared Corporate America into believing the current economic outlook is so bad it justifies QE.  As a result, corporations have curtailed investment in new hires, plant and equipment.  Instead, they are taking advantage of ultra-low interest rates to issue corporate bonds to fund operations, rather than repatriate foreign profits -which would be taxed (Apple has recently done this).  They are also holding a lot of cash.  U.S. nonfinancial companies had $1.8 trillion in cash on their books at the end of the second quarter, according to the Federal Reserve’s quarterly “flow of funds” report.  In absolute terms, cash holdings are at an all-time high, even after adjusting for inflation.   


In addition, Corporate America used to pay approximately 7% of U.S. GDP in taxes in the 1950's.  Today it pays only about 1.75% of GDP - at an average tax rate of 12.5%- not the 35% stated corporate tax rate that many say is much too high.  Lobbying and political contributions have certainly paid off big time here! 

For the most part, the real economy is very dependent on fiscal policy, which has been on hold for years, due to political struggles/gridlock between the Obama administration and Congress.  This is the principal reason the U.S. economy is stagnating, with very low growth, high unemployment and more discouraged workers dropping out of the labor force.  Five years of monetary stimulus has produced a stock market bubble (which many now are shouting about, e.g. Andrew Barry in this week's Barron's cover story), but it has done very little -perhaps nothing- to help the real economy and the man on the street.

But now, a potential major change in the corporate world and the economy has entered the mix.  It's officially called the Patient Protection and Affordable Care Act (ACA), which is more commonly known as "ObamaCare." 18% of U.S. GDP is related to health care, which will now be controlled by the federal government.

Background on the ACA:

The ACA was passed with 100% of Democratic votes in both the U.S. House of Representatives and Senate.  Congressional representatives of several states were enticed or lured to vote it into legislation.  Coined slogans such as "The Louisiana Purchase" and "The Cornhusker Kickback," (among others) were used to designate the  "buying" of  the votes to pass the ACA, which occurred on Christmas eve - 12/24/09 -while the public was out celebrating that joyous holiday. 

The ACA Congressional voting chicanery was not forgotten by the Republican Party.  It has resulted in many huge battles which attempted to stop or repeal the ACA.  Once it's fully operational, the ACA will control approximately one sixth (1/6) of U.S. GDP. 

The latest battle began when the problems of actually implementing the ACA became widely apparent and many complaints were voiced.  But beyond the perpetual 45 day website "glitches" are the planned cancelations of many private health insurance policies which must be switched to ACA mandated health plans.  The latter are much more expensive, because they include many options not needed by most people.  For example, does a 55 year old couple need "maternity" insurance?

The real problem with ACA, which can't be fixed by any website IT department, is forcing approximately 15%-20% of private health insurance customers to buy expensive and mandated new policies.  That's really a tax on the middle class (e.g. those that make over $64 thousand).  It causes people over 26 years old to overpay their insurance premiums in order to defray costs for older and/or people with preexisting conditions.

The ACA's hidden agenda is to collect higher premiums (i.e. effectively a hidden tax) to pay for the people who did not buy, or could not otherwise afford, health insurance at a reasonable price. The ACA plan has been a disaster from inception.  It's been exacerbated by the public's inability to shop for health insurance on the dysfunctional ACA web site.  [We wonder why that website wasn't stress tested before it went live.].  The number of people adversely affected is way underestimated, in our opinion.  This is all due to inept federal government management of the ACA.  We don't think it's likely to improve anytime soon.


The "Obama spin" on the number of people affected by the letters of insurance cancellations for existing policies is "ONLY 5%" (of 315 million U.S. population) or 15 million people. This seems to be yet another statistical lie.  In 2010, the Obama administration estimated that 93 million Americans would be unable to keep their prior health coverage under the narrow grandfathering provisions issued by the administration in June 2010.  Chris Conover (who works at the Center for Health Policy and Inequalities Research at Duke University) estimates that the number is now 129 million. 


President Obama announced this week that his administration would unilaterally decline to enforce the provisions of ObamaCare responsible for millions of insurance policy cancellations around the country. “The bottom line is insurers can extend current plans that would otherwise be canceled into 2014,” he said. The real bottom line is:  If you like your plan, you might be able to keep it for another year. But after the midterm elections are over, non-ObamaCare-compliant plans will get canceled yet again. Because, if the delay continues past 2014, one ObamaCare architect believes it “could be the beginning of a death spiral” for the law’s insurance exchanges.


Americans buy health insurance as a "family."  According to the 2010 census, there are 114.8 families in the US {now estimated to be 122 million families}, with "2.6 people per household."  Therefore, if the individual market is 15 million people then the insurance per household cancellations should be 2.6 (for the average family) X's 15 million which equals 39 million people or 13% of U.S. households!


When will the ACA be understood for what it is and what it is going to be?  It is possible that it will implode, but not likely until the next Presidential election.  Will we see a repeat of the 2010 "little big horn" battle in the Republican controlled House of Representatives? And if enough Democrats turn sour on the ACA, in the Senate as well? 


Impact of the ACA on the Real Economy:

The ACA will certainly have a negative impact on the real economy.  Companies have already resorted to part-time hiring to escape the burden of paying for ACA mandated health insurance for full time employees.  Many consumers will hold back on buying non-essential items to offset the increases in ACA costs they must now pay. This decrease in discretionary spending should translate into a further slowdown in U.S. GDP which has been way below 3% trend growth since the great recession ended in June 2009.


According to the Heritage Foundation, new taxes on drug companies ($27 billion) and medical device makers ($20 billion), as well as new reporting requirements and regulations imposed on physicians, will make access to health care and services more costly and difficult for seniors under ObamaCare.   


Richard McGregor wrote in this weekend's Financial Times: "Barack Obama faces a slow-motion dismemberment of his presidency and mass defection of once-loyal Democrats ahead of next year’s elections unless the White House fixes the troubled rollout of his new healthcare system.  The news that only a fraction of the people needed to make the system viable had managed to sign up for insurance in the first weeks of the online exchange has started to panic many Democrats in Congress.  Without a solution to attract more customers, the White House policy will be shredded by regular bulletins about its shortcomings, with far-reaching implications for Mr. Obama’s second term."


The editorial in that same FT paper was even more critical:  "So far, Mr. Obama’s interventions have only made a bad situation worse.......The danger is that ObamaCare’s woes could jeopardize prospects for doing anything else.  Congress pays close attention to polls and the US public’s trust in government – and its personal trust in Mr. Obama – is plummeting. Republicans were responsible for last month’s government shutdown. But approval ratings for Democrats have now fallen almost as low. This is a recipe for (U.S. government) paralysis........ There are also concerns about whether Congress can reach a deal to stop the next scheduled government shutdown in mid-January."


So the odds favor continued sluggish economic growth and/or a further economic slowdown early next year. The negative effects and uncertainty of the ACA will surely keep a lid on job growth and result in continued high unemployment.  It might even tip the weak U.S. economy into a new recession by the second quarter of 2014.


Equity Market Reaction to an Economic Slowdown:


In the recent past, "bad news was good news" for the stock market.  That's because bad economic numbers meant the Fed would continue QE (and defer tapering).  If the economy continues to stagnate (or go into a recession due to negative effects of Obama-care) what will be the Fed's response and the effect on the market?


Recent history and Congressional testimony dictate the likely response by the (then Yellen led) Fed would be to add more liquidity, i.e. more QE (How about $150 billion a month of bond purchases?).  This reckless monetary policy has occurred for five years now, with scant GDP growth and continued high unemployment. It’s ballooned the Fed's balance sheet* close to $3.6 trillion, but has done very little for Main Street. Yet Wall Street wins big and few complain. For example, President Obama got re-elected on poor economic numbers and very bad job numbers. 


* The Fed's balance sheet refers to the net total of U.S. Treasury debt, agency debt, and mortgage-backed securities held by the Fed.  It's currently=$3,537,748 as per the latest Fed release. That's up from < $1 trillion prior to the last recession.


As former FOMC member Wayne Angel said:  "There has never been a (post WW II) recession unless the Fed wanted one."  And for sure, neither Bernanke nor Yellen want one now.


But recessions and bear markets have not been eliminated, contrary to what some pundits have said now and in the past.  As a result, the success of any monetary policy (e.g. Fed QE and ZIRP) can only be judged in terms of a FULL CYCLE for the economy and stock market.


End Game will NOT be pretty:


The end won't be a soft landing, as many bulls believe.  The current U.S. stock market is not built on solid fundamentals, but on Fed supplied liquidity and the "greater fool theory."  So the higher the market is manipulated up, the more difficult it wiil be to avoid a huge crash landing with disastrous losses for stock holders in the end.


How bad an ending?  That's difficult to quantify.  A mistake can be anything that politicians desire greatly [like Democrats and the ACA], but don't understand the consequences or effects.


We have seen this  in history many times before...Herbert Hoover with the Smoot Hawley tariff Act  and the tax increase of 1931-32, Fed Chair Marriner S Eccles tightening credit in 1937, President Kennedy in 1962 on control of steel prices, President Nixon's price controls in 1971, Secretary of Treasury James Baker with a threat to devalue the dollar in October, 1987, Fed Chairman Ben  Bernanke and U.S. Treasury head Hank Paulson letting Lehman Brothers fail in September 2008, and many, many more.


The next mistake will cause a grand financial crisis, as the pillars of freedom and economic strength are now very weak.   There is simply no buffer or wiggle room to effectively combat the next recession or a stock market panic sell-off that turns into a colossal wipe-out.


Till next time........................


The Curmudgeon

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 1979) to profit in the ever changing and arcane world of markets, economies and government policies.  As President and CEO of Alpha Financial Technologies LLC, Sperandeo overseas the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.