Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
- History Does Rhyme … But Times Are Far From Identical
- Week in Review
1. History Does Rhyme … But Times Are Far From Identical: In response to economic weakness and the prospect of Fed intervention, the stock market indexes have risen an average of 14% since July of this year. As is normally the case, the tape writes the headlines and the headlines imprint the attitudes of economists. More and more, as stocks and bonds advance, due to Fed leniency and intervention, Wall Street and its opinions grow bolder.
Recently, I have been able to peruse a few reports from competing firms, and most refer to our present condition as difficult, but getting better, and our future, to be bright and no different from past recessions.
Specifically, many continue to compare this crisis with that of the 1989 S&L crisis, which set off a recession that lasted until roughly mid-1993. Arguably the crisis of 1989 was significant, and no doubt, produced substantial losses for those with selective exposure to garbage loans. Inflation, debt, deficits, unemployment, stocks, and housing also were issues during this time, as they are today. And I also suppose that if you read the headlines of that era vs. now, they would be almost identical. History does rhyme, as our learned colleagues would eagerly suggest. But in our opinion, it is far from being identical. The devil is in the details, as they say. With that notion, I would like to make two major points of comparison.
The first is in regard to solvency. In 1990 total debt (Federal, Household, Municipal, Corporate, and Financial) of the U.S. was $12.8 Trillion and total GDP was $5.5 Trillion (for a ratio of 2.3). Today, that relationship is radically different, where total debt is $52.2 Trillion compared to GDP of $13.1 Trillion (for a ratio of 4.0). Most entities that have breached 3.5 on the ratio are in essence insolvent (no wonder the Fed wants to print), due to the inability to service the debt from pre-interest income. Do you remember Enron, Worldcom, Bear Sterns? They all had similar dynamics in comparison to the United States presently.
The second point is in regard to real returns. In the period beginning in 1989 and ending in and around 1995. Stocks advanced in record form, while commodities, on average, fell. Here are some of the returns and stats from that period:
Jan 1989 to Jan 1996
Dow Industrials 135.96%
S&P 500 121.78%
Nasdaq Comp 175.88%
Crude Oil 13.40%
CRY Index (Commod Res Brd) -3.43%
Today that picture is again, very different. We could pick year 2000 as a starting point of this crisis, when the Nasdaq fell apart. But we would rather keep this comparison limited to a five or six year stretch. So, below I have provided the stats on the same indexes for the period between 2005 (when housing began to roll over) and the present day.
June 2005 to Oct 2010
Dow Industrials 3.78%
S&P 500 -3.68%
Nasdaq Comp 14.7%
Crude Oil 49.8%
CRY Index (Commod Res Brd) -5.60%
The numbers would look similar if we took the sample from year 2000 forward as well. In any case, the returns are clearly stacked in favor of the commodities. That simply means costs are going up and margins are getting squeezed in the corporate sector – a completely different scene from the 1990s.
So, as the Fed prints (to save us from immediate bankruptcy), this bifurcated relationship between stocks and commodities grows – producing negative real rates return for those in stocks – in general. This is a condition we expect to continue until voters scream uncle … or something along those lines.
2. Week in review: Stocks, bonds, and gold continued to rise, while the dollar fell sharply on any prospect of economic weakness. Although the data was mixed again, weak Factory Orders, ABC Consumer Confidence, ADP employment, Continuing claims, and Non-farm payrolls were enough to stoke the fires once again for QE part II. Japan lowered its interest rates to zero to stem the loss of the Yen against the dollar. And China extended its stimulus, both internally and abroad (potentially in Europe, Greece), while Ireland increased its total bailout from the ECB to €119.1 Billion in loans.
Although the global and domestic economic situation is still shaky and the election is in tow, we can’t help but feel that the Fed is overreacting, or that Wall Street is getting carried away with speculation. The Fed may want to pull in the reigns a bit in their policy meeting November 3rd (the Fed already leaked this concern to the WSJ last week).
If they do moderate policy, it could temporarily put the screws on the runaway markets and the near vertical drop in the dollar. However, we have seen a careless Fed in the past, and if one looks at the debt levels in this country versus our earnings, it’s easy to see the larger concern – and consequently, what their bias will be in the long run.
Have a wonderful weekend.
VP Investment Management
President and CEO