Market Watch - October 5, 2004
On August 31st, California Governor Schwarzenegger
said “those who contend that the American economy is in trouble
are economic girly men.”
President Clinton dug into his vast reservoir of political lexicon
to give us a new definition of “is”. Perhaps Governor
Schwarzenegger, having become a politician, has coined new definitions
for “trouble”, so it is important for Market Watch to
define our goal: “To tell the truth based upon existing mathematical
and economic facts that, when properly analyzed, access the probability
of the stock markets making us money without undo risk.”
With that in mind it is sometimes easier to turn to opinion’s
of people who are at the center of economic policy making.
| 1) | |
Caroline Baum, the brilliant Bloomberg columnist recently provided a list of what’s wrong (www.bloomberg.com): “There are no savings; budget deficits are too large; oil prices are too high; health care costs are too high; wage growth is too slow; trade deficit is unsustainable; stimulus from tax cuts and mortgage refinancing is fading; consumer is tapped out; corporations are cautious; good jobs are going overseas; and fiscal policy is misguided.” |
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America Institute of Economic Research: “residential real-estate values have risen a total of $6 trillion representing a 50% increase in only five years. This matches the highest rates of increase in the past 50 years. The previous peaks in 1979 and 1988 proved to be short lived." |
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Stephen Roach, Morgan Stanley’s Chief Economist, writes: “In the world of economic growth, savings must always equal investment. Savings have fallen short of investment for many years in this country. The US economy has added $1.3 trillion to its GDP in the last 3 years, but during that same period, it added $4.2 trillion to debt. From 1952 to 1988, each new dollar of GDP meant an additional $1.65 in debt. The first 3 years of this century, $3.19 worth of debt has been added for every new dollar of GDP.” Market Watch comment: Debt negatively impacts wages, taxes and the standard of living. |
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According to former US Treasury Secretary Bob Ruben and former Federal Reserve Board Chairman, Paul Volcker, “Our economy is presently in a position where the odds of a major financial crisis in the next 5 years are 75%.” |
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Fortune magazine recently published an article by Lawrence Kotlikoff (Boston University Economics Department Head) entitled “Why Things Could Get Really Bad” which was a summary of his best selling book. Kotlikoff writes, “Hyperinflation is a real danger because the US government is effectively bankrupt. The fiscal gap (future un-funded government obligations) is $51 trillion. That’s 11.6 times official debt, 4.5 times GDP and 1.2 times private net worth. $51 trillion to meet future obligations for Medicare and Social Security would require immediately increasing Federal Income Taxes 78%, cutting Social Security and Medicare benefits 51%, or eliminating all Federal discretionary spending. When investors around the world wake up to US insolvency, it will be extremely expensive for our government to borrow. The only option, therefore, will be to print huge sums of money, thereby generating hyperinflation.” Market Watch comment: The only way to avoid this is to take action now, the very thing our leaders in Washington are not even talking about. |
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| 6) | |
Richard Koo in his new book “Balance Sheet Recession” points out that major corporations are reducing debts and putting themselves in a non-expansion posture like Japan did beginning in 1990. Japan has weathered their long recession because of a high rate of savings while American’s have a net negative savings rate. We cannot look forward to wage increases to keep up with inflation, nor high paying new jobs to accommodate an increasing work force. The loss of jobs to China and India not only continues, it is accelerating. |
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Pete Peterson’s new bestseller, “Running on Empty”, is subtitled “ How the Democratic and Republican parties are bankrupting our future and what Americans can do about it”. This financial and business giant also pegs un-funded US liabilities between $45 trillion and $53 trillion which will start to become a problem when baby boomers begin to receive benefits the next few years. No politician is talking about it or figuring out how to solve the problem. Allen Greenspan said in August “As a nation, we owe it to our retirees to promise only benefits that can be delivered. If we have promised more than our economy has the ability to deliver to our retirees without undoing diminishing real income gains of workers, as I fear we may have, we must recalibrate our programs.” That is Greenspeak for “we are facing some real troubling times and if we do not face it soon it will cause unbelievable economic pain”. |
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The General Accounting office writes that “the next president will face a projected $2.3 trillion 10 year fiscal gap including an estimated $483 billion deficit the fiscal year just began.” Market Watch comment: Both of these numbers are probably low based upon current obligations and the government’s record of meeting estimates. To compound this problem, every major economy in the world is reducing growth expectations because current higher estimates have not been met. |
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Even our government experts cannot agree on the estimated future gap of government Social Security and Medicaid obligations. The government accounting office estimates $40 trillion, and the Social Security Board of Trustees estimates $72 trillion. Market Watch comment: What gives when the two major agencies of our government responsible for these payments cannot agree on our obligations? And the difference between the two estimates equals almost 3 years of our current GDP! |
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Former US Treasury Secretary Paul O’Neill promoted a study, which got him fired. The study concluded: “To get out of this mess we must double current payroll taxes from 15% to 32%, raise income taxes by 2/3rds immediately and cut Social Security and Medicare benefits by 45%”. |
CONCLUSION
There are huge overbearing financial drags on the US economy, which
make the mathematical odds of the stock market improving over the
next several years very low. For every GM car made, $1,360 of that
price goes to pension and health care costs as compared to only
$107 committed to the same benefits for every new Honda made. This
economy is full of imbalances like this and they are unsustainable.
QUESTION: How do you make money
in this kind of market? ANSWER: With great difficulty. Concentrate
upon not losing money. One does not “play” this market,
one watches and stays in liquid funds (Pimco closed end bond funds
yield around 7%, and there are other reputable low risk “cash
type” funds, too, all listed in Barrons every week).
The good news is that investors and advisors remain optimistic.
Politicians like Governor Schwarzenegger help keep hopes up with
their optimistic outlooks, and we can only pray that while these
uplifting speeches are taking place, someone in our government will
get their act together and pass legislation to minimize future damage.
There is a road to riches, even in these difficult times. And that
is spend less than you make and buy less than you can afford; don’t
gamble; save; live conservatively; stay out of debt; use the magic
of compounding; borrow only to purchase a house or fund a business
and then pay the debt off before it is due; and wait for opportunities
to invest that reflect value. The history of economics, well known
as the “dismal science”, is a reversion to mean values.
We are not there - - the stock market, in particular, and many other
markets like commodities and real estate, are grossly overvalued.
Over time they will present buying opportunities that will place
those who save and remain in cash in a position to make huge future
capital gains.
When will this happen? Who knows? What can we do about the economic
mess that exists today? Two things: (1) have a massive truth telling
effort where the American people really understand what we are inflicting
upon the future and on our children; and (2) then, bold action by
a president and an administration who are willing to show leadership.
Otherwise, and this is the desire of both major political parties,
we will probably muddle through this major world economic displacement.
We’ll happily survive, and because America is America, we’ll
redefine and remake our leadership nitch in the world. But the essential
question for this column is “with this huge overhanging economic
mess, when can we start making money in the stock market”?
And the answer is: without speculating, not for a long time!
Caveat Emptor!
George Rauch
October 5, 2004
