Market Watch - March 22, 2019
After the elections settled down, the market started moving upwards. This is the strongest economy in world history, where everybody wins: employers are reinvesting money and labor is achieving economic gains like never before; government revenues are at record levels.
The usual problems of increasing government spending, and commensurate increasing public debt, remain at the top of the list of potential economic problems.
Question: It’s mentioned our economy is firing on all cylinders, but what about housing, which we have been led to believe is softening?
Answer: Housing is extremely sensitive to changes in interest rates. Such increases definitely began to put a damper on home building three quarters ago.
However, the increase in housing prices has now slowed down. Mortgage rates have backed off to reach a level where strong housing growth can be sustained. Homebuilders are on the move again.
Question: What can be done about increasing government expenditures?
Answer: That’s very difficult. Each congressman and senator has their own set of “backers”, who expect them to vote favorably upon legislation that can be affected by their political donations. Few of our elected officials have the strength of character, and the resolve, to participate in drastically cutting departments.
There is so much fat in government. An example of what can be done is the present administration’s White House budget. Salaries equal $35.8 million annually. The prior administrations last White House budget for salaries was $60.9 million. That is a reduction of 70% annually. 70% is not available in other departments, but a significant percentage is available.
Since such a large part of the budget is on indexed increases, it’s difficult to control growing government expenditures. The best we can hope for is probably what we are getting, piecemeal cuts here and there, and changes in the imbalance of tariffs. Already, with an expanding economy, welfare roles are decreasing in concert with the decrease in the number of people unemployed. Almost every area of our economy is producing record sales and profits.
Question: With talk about foreign economies slowing down, can we expect a recession?
Answer: It is doubtful the U.S. economy will do anything but prosper in the next several years. Exports are not a huge part of our economy, although they are important, and growing. Consumer spending is the largest component of our GDP. Baby Boomers own 50% of U.S. wealth themselves, and they control 77% of the country’s wealth. For the next several years they are retiring, selling homes and building new houses. They are buying all sorts of consumer goods, donating money to charity, and passing funds to the next generation. This dramatic shift in wealth, and the commensurate spending, will help fuel the growth of our economy for the next several years.
Further, as to world GDP slowing down, the numbers have been revised from 3.3% expected growth this year, to 3.1%, not a huge difference.
Question: It’s mentioned above that labor is achieving historic economic gains. How are our lowest wage earning citizens fairing in all of this economic prosperity?
Answer: Like everything else the last several years, wage growth has been unparalleled. That growth has favored the lowest wage earners, who have enjoyed the largest earnings increases. As long as there is a shortage of labor, wage growth will remain on the rise.
Question: U.S. federal debt just surpassed $22 trillion. It will exceed the budgeted deficit. What will be the aftermath of these continuous budget increases?
Answer: The increases cannot be sustained. When governments go broke, as the U.S. has several times in it’s history, it is always because they cannot meet interest payments, and/or new money cannot be raised to pay current government bills. In this market, with record cash flow, government has come up with record expenditures, rather than use increased tax revenue to slow down the increase in government spending. Where we may run into trouble is that all of these budget commitments have been made for many years ahead.
If we have an economic slowdown, tax revenues will slow down while expenditures remain the same, or increase. If the government runs out of cash in a recession, and they cannot sell any more securities to the public, they go into default. When it will happen, nobody knows, but it is a certainty that we will somehow have to reckon with the debt piled upon us by politicians.
Historically, governments created debt to finance wars. We did that in WWI and WWII. Of all the skirmishes we have been involved in since Vietnam, not one dime of our $22 trillion debt has been used for war, but rather, for welfare.
Question: In such a scenario where the U.S. cannot sell or refinance its debt, how does that effect the private sector’s wealth and ability to operate?
Answer: The private sector’s wealth really is separate from government problems. When government problems occur, the bond market goes down, pushing interest rates up. The stock market usually goes down, too, pushing dividend yields up, because investors sense more risk in the market place. They want to be rewarded accordingly for participation in a riskier economic environment.
During government financial meltdowns, private sector growth is slowed; however, the private economy continues to operate while, usually for several months, bankers and other sectors of our economy who own government debt, negotiate with the government and the Federal Reserve system to restore financial credibility. That necessitates writing off a lot of government bills, and negotiating with bondholders who will lose lots of money. What will suffer the most is vendors owed money by the government, banks, and investment portfolios that require investments in government bonds, such as pension funds. Such a reckoning takes economic disorder out of the economy.
Question: When will this happen?
Answer: Only economic circumstances can determine that. There is news about New York City filing bankruptcy. Chicago is in trouble, as are several other major cities, and states. But the truth of the matter is that the U.S. Government is more broke than any of them. The government is $22 trillion in debt with no plan to pay it off, and no hope, at this point, to develop a plan. Politicians have avoided all legislation to balance the budget, and they’ve continued to vote for increases in the debt to cover budgets.
Conclusion
Future stock market growth will depend upon corporate earnings reports over the next few quarters. At the moment we can expect the market to trade in a range of a few thousand points. While the market remains strong, it is unlikely to experience considerable gains without continued increases in corporate earnings and some resolution of our disagreement over tariffs.
While expanding government debt can hurt the markets and the economy, a long-term view of the market during this 40-year debt build-up is telling. In 1978, the DJIA closed at 805 points, as compared to last year’s closing of 23, 327 points, a gain of 29 times the market’s closing 1978 price. The last 40 years has witnessed the end of the Industrial Revolution, and the beginning of the Technological Revolution. America dominated the industrial revolution. There is every reason to believe we will continue to play the primary leadership role in the Technological Revolution, and enjoy continued prosperity, with little fear of severe slowdowns in our economy.
Whether the next 40-years will yield financial results equal to the last 40-years is unknown. What is known is that our economy is in a better position to meet future economic demands than any other country in the world.
George Rauch
March 22, 2019
