a tale of two economies - twitter

Friday Federal Reserve Chairperson, Janet Yellen, representing her team of Federal Open Market Committee stated that,

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“In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the Federal funds rate has strengthened in recent months.”

Oh really?  The Dow Jones Industrial Average had been positive all Friday morning and was up around 100 points before Ms. Yellen’s remarks.  Shortly after this statement, buyers turned into sellers and reversed the gain into a 100-point loss.  Why the disconnect?  The Federal Reserve testified that economic conditions “has strengthened” and the obvious response should be more buying not selling as companies and their values should increase with economic growth.

We have increased our respect for Ms. Yellen and her committee during her tenure as they seem to be the only central committee in the world telling politicians that they are not paying for poor fiscal (legislative) policies anymore.  The world has followed the US fiscal policy lead to massive and historic levels of deficit spending and monetary stimulus (exceeding $10 Trillion since 2007) while passing legislation primarily impacting small-medium sized companies and middle Americans.  The result in the US is the slowest economic “recovery” since 1949, and without surprise, the results are the same around the globe.  We have discussed in this space that the majority of the US economy is powered and employed by average American consumers and small-medium sized companies. If incomes of ordinary Americans are stagnating, then expect the economy to stagnate.

However, the massive stimulus and deficit spending has had its impact.  The wealthy and politicians have prospered exceedingly.  This weekend Barron’s writes:

“While the central bank dealt forcefully with the 2007-2008 financial crisis, it failed to anticipate and subsequently failed to bring about a recovery worthy of the name. What it has accomplished is a massive inflation, not of consumer prices – as officially measured, at least – but of asset prices… Since then, Wilshire Associates estimates the value of U.S. equities has increased by over 100%, some $13.3 trillion. Since Bernanke [former federal reserve chairperson] outlined QE3 in September 2012, U.S. equities are up about 50%, or $8.6 trillion, by Wilshire’s reckoning.”

If you are among the lucky with healthy investments in retirement plans, exotic cars, art, jewelry, stocks, and real estate, these past seven years have been fantastic.  The inflation factor for most middle and lower income Americans has been nearly flat, especially with the decline in gas and energy prices.  However, the wealthy and ultra-wealthy with money to spend have created 10% to 50% annual inflation for assets that include luxury cars, 5 Star hotels and vacations, 10,000+ square foot mansions, jewelry, collectible art, and front row seats at professional championship events.

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2016 Mercedes-Benz AMG S retails for $234,050 that was a mere $180,000 in 2010.

Each week it seems the Wall Street Journal in its weekend real estate edition reports a new all-time selling price of houses in America (now well above $100M) and last week featured an article of “mansion collectors,” individuals that collect mansions around the world.  CEO’s annual incomes have soared these past seven years while American middle incomes remained nearly the same.

As investors listened to Ms. Yellen, they must have been thinking, “if the past seven year’s combination of massive stimulus and weak fiscal policies only produced a slowly growing economy that primarily benefited the wealthy, what will poor fiscal policies with no Federal stimulus produce?”  Sell.

The ailing tolerance by low and middle-income earners is evident by the surprised Brexit vote and rise of US presidential candidates rallying against the status quo.  We don’t foresee a near-term derailment of the stock market rally.  However, at some point sustainable economic growth among the core of American consumers must intervene to support upward soaring asset prices or there will be an adjustment.  We applaud Ms. Yellen’s convictions to hold her ground and pursue monetary policy contrary by most central bankers of zero to negative interest rates and stimulus programs. However, without a similar reform of fiscal policies, the adverse consequences may impact everyone.

WHAT DOES THIS MEAN TO ME?

Pricing of stocks reflects both the current and potential growth of corporate earnings.  It is not unusual for stocks to rally or selloff well past their historic ratios of values as investors speculate on the direction of corporate earnings.  Currently, the US stock market indices are in a technical bullish trend with no indications of weakening.  We remain cautiously optimistic that stock prices will hold current prices and may continue to rally.  However, rallies end when projected earnings and economic growth don’t match investor’s expectation and possibly Friday’s DJIA reversal was investors reconsidering their optimistic forecasts with same fiscal policies and no Federal Reserve stimulus.

Let us know your thoughts by leaving a comment in the section below… we might even use it for a podcast!