Market Watch - May 28, 2014

Economic Realities Could Depress Bull Market
Further Market Price Increases at Risk

The stock market continues to set records. Highly priced in terms of average values, the market gets more expensive every month. This is a bull market, but there remains a host of reasons to give investors pause when contemplating further investments in the stock market.

1. A time-honored method of evaluating the fairness of stock prices is a company’s payment of dividends to stockholders, or what is called the cash dividend yield. The DJIA is 16,500 points, and the dividend yield is 2.2%. Based upon historical dividend yields of 4.2%, the market would be at 8,600 points. There is no clearer indication the market is overpriced.
2. As the chart points out, the Census Bureau indicates 86 million full-time private sector workers sustain benefits for 109 million recipients of welfare who pay nothing into the system. Factor in 17 million government workers, and the financial burden upon the 86 million employed Americans becomes onerous.
   
   

   2012 census Bureau Statistics
   Full-time Workers	103,087,000
   Less Government Employees (*)	16,606,000
   Private Sector Employees	86,481,000
   Number Receiving Monthly Benefit Checks	151,014,000
   Paid-in (“Deserving”) Recipients (**)	42,000,000
   Hard Welfare Recipients (***)	109,014,000

   
   (*) 12,597,000 state and local, and 4,009,000 federal.
   (**) Social Security, veterans, unemployment compensation, etc.
   (***) Food Stamps, government housing, Medicaid, and other means-tested programs.
   
   
3. A current subject in Congressional and Senate tax committees is taxing the huge pools of cash available on balance sheets of U. S. corporations. If that happens, dividend increases will be curtailed. Cash currently available for expansion will be used for taxes. Further justification for market increases will be abated. With public awareness that taxes will hurt corporate balance sheets, there exists a potential market sell off.
4. We have experienced 7 million foreclosures the last few years. Nine million homeowners live in houses that are less valuable than what is owed on the house. Additional millions are in homes with no equity, just covering mortgage costs. If normalization of our low interest rates occur, housing affordability becomes even more difficult. There has been no wage growth the last several years. The average family makes just under $50,000, down from almost $54,000 annually five years ago. Greenspan forced interest rates from 6.5% in 2000 to 1% by 2003. According to the Mortgage Bankers Assn., an increase of mortgage rates to just average levels is likely to spur millions of additional foreclosures. There would likely be a recreation of the mortgage mess of a few years ago and the attendant effects upon the markets.
5. Prolific economic author Peter Schiff frequently writes about the “phony economy that is completely dependent on the ability to borrow money we cannot pay back. We must borrow just to pay interest on government debt. A look at our budget deficit, and our debt to GDP ratio, indicates that if we were in the Eurozone, we’d fail the liquidity ratios. They would kick us out.” He goes on to say, “A collapse of the dollar, or a huge spike in interest rates, will cause our unemployment to skyrocket. Credit will dry up, and the dollar will collapse, completely wiping out all savings, and sending consumer prices into the stratosphere”. We are, in fact, already witnessing the slow collapse of the dollar in international markets, along with deterioration of the dollar’s purchasing power through inflation.
6. The effects of Dodd-Frank have been devastating. Our “too big to fail” banks remain in bad shape. Average compensation at the FDIC, which regulates banks, now exceeds $190,000 annually, more than the average salary of the “fat cat bankers” they’re regulating. The cumulative number of hours spent on regulatory paperwork in 2013 was 10.4 billion hours (American Action Forum), and government is adding one more regulation to the Federal Register every three hours! Increased costs from government regulation make our products more expensive and less competitive in world markets.
7. High frequency trading (HFT) continues to make income for Wall Street trading houses while hiding from the public the real commission costs. The public is paying at least an additional $32 billion in stock and bond commissions they are currently unaware of, which commissions are found in hidden trading procedures. Michael Lewis’ new book Flash Boys is an amazing disclosure of this deception. A big falling out over this behavior could negatively affect the public’s trust of the markets as well as the banks involved in the brokerage schemes, many of whom are the “too big to fail” banks.
8. We are led to believe that Republicans and Democrats have differences, yet they continue to do the same things. We know something is wrong, but where is the evidence? Here are some interesting numbers:
   
   

   78 Debt Ceiling Increases since 1960
   With Republicans in Power	49
   With Democrats in Power	29
   Total =	78

   
   The Republican Party has the reputation of watching over our money. The Republican Party is “conservative, vicious, and unyielding in their attempt to cut spending”. But, they have allowed the vehicle for bigger government and more spending 70% more often than the Democrats. Look beyond the rhetoric of both parties and understand what is really occurring. Both parties are socialistic. Both parties love, above anything else, the power, perks and financial benefits of big government. It has been proven they will not reduce the size of government. There must follow, therefore, continuous increases in debt which will clearly harm the market. The economy can’t absorb additional debt loads.
9. Finally, this market has been supported by the Fed manufacturing at least a trillion new dollars annually out of nowhere with no other reason than to make welfare payments. A reduction in this “quantitative easing” will direct funds away from the market. Fewer funds means less demand which can result in a reduction of stock market values.
   
   

Summary

In taking into account major economic factors and the political and demographic structure existing in our economy, it is hard to see how the market will continue to grow. It is difficult to rationalize the market being at these levels. Logic dictates our markets are not only fully priced, but they are over-priced. Further additions to our stock and bond portfolios may subject one to more risk than prudent investors need acquire.

Caveat Emptor.
George Rauch
May 28, 2014