Do Election Results Favor The Stock Market?

No. The Standard and Poor Index of 500 stocks is selling at a bull market high of 21 times earnings and yielding a teeny 1.7% (payout of dividends). Even though the Dow has had a nice 600 point run the last month, it’s starting to back off, and the market remains in the same trading range that’s existed for 18 months. Stocks at these prices are already overvalued. Increased earnings would add value to stocks. It appears, however, as if profits have tapered off and the odds of the market going down further are equal to or greater then the market going up in value.

The Dollar Drag

The dollar is down 48% against the euro and 21% against the yen over the last two years. That means, for example, that a European investor who purchased a condo in the U.S. for 200,000 euros a few years ago could now sell the condo and convert the proceeds back into only 100,000 euros, a 50% loss. Alternatively, that same condo the European investor could have purchased two years ago for 200,000 euros could now be purchased for 100,000 euros, a real bargain.

The cheap dollar should create attractive U.S. investments for foreigners except for three problems:

1)		Foreign investors have lost lots of money on U.S. investments the last several years;

2)		Worldwide cash flow is being squeezed as foreign economies suffer from unemployment and recession;

3)		The rest of the world thinks the dollar will sink further, and they have no appetite for loosing more money on dollar-backed investments.

As increases in debt are attached to the dollar, the dollar incurs obligations it didn’t previously have. This places downward pressure upon the dollar’s value. The reverse is true for economies that accumulate cash and reduce their debts. Debt can be equated to a shortage of cash. The U.S., with 70% of the world’s monetary reserves in dollars, has been able to supplement cash shortages by simply printing money with no asset backing those newly printed dollars (like gold, silver, real estate, etc.). The economic result of this type of behavior is inflation. The world’s assets have not increased but the supply of money has increased. Therefore, if more and more dollars are available to purchase a fixed amount of assets, the price of these assets will increase to meet the expanding supply of cash.

Since the U.S. went off of the gold standard in 1932, there’s nothing to support the value of the dollar except “the full faith and credit” of the Federal Reserve System who declare that dollars are “notes of legal tender for all debts, public and private”. Since 1932, the value (purchasing power) of our dollar has been reduced by 95%. If our money was backed by gold it could not be inflated or debased. Gold was fixed by Congress in 1791 at $20.00 an ounce, and it held that value for almost 150 years until 1932. From 1932 when gold was confiscated by the Federal Government, gold has risen in value from $20.00 an ounce to over $400.00 an ounce. The increase in the value of gold has pretty much tracked the decrease in the dollars’ purchasing power. An ounce of gold still buys what an ounce of gold bought in 1932. ($20.00 an ounce divided by $400 an ounce equals 5%. The current U.S. dollar has 5% of the purchasing power it had in 1932).

Queen Victoria preached that ownership of foreign assets was the road to national wealth. She felt that foreign ownership of assets defined a countries’ true power and standing in the world. In 1980, America’s net international investment position (U.S. claims on foreign assets) was a $360 billion surplus. At the end of 2003, America’s net investment position overseas was a negative $2.4 trillion. In 20 years America went from the largest creditor nation in the world to the largest debtor nation in the world.

What’s to keep the Market From Advancing?

The stock market is cold blooded, and it cares about one thing and one thing only: PROFITS. The market has no social agenda. The market is an unemotional “profit calculator” that is interested in little else but “more income”. Profits will continue to be hurt by large amounts of interest payments due on debt. Both debts and interest rates are headed even higher.

Foreign purchases of U.S. Treasury securities were down 50% in October. With a falling dollar, the only way to continue to attract foreign capital to fund U.S. trade deficits, and U.S. Federal spending deficits, is to make treasury securities more attractive by increasing interest rates. That’s now happening. Increased interest rates will be a drain on profits.

The week of November 17th, Congress sneaked through and authorized an increase in our national debt of $800 billion (with almost no debate and no publicity!). This amounts to another $11,000 of debt for every family in America. Most voters have no clue what’s happening to our obligations, complements of the U.S. Government. As our government spends billions of dollars a day more than it’s tax revenues, the $800 billion will be gone soon. This is a further drain on profits.

What To Do?

When contemplating the purchase of a stock, it’s wise to ask oneself two questions:

1)		If I’m wrong, what will be the penalty?

2)		What is the primary trend of the market, not the secondary trend? A secondary trend (the Dow recently up 600 points) is a correction of the primary trend. The primary trend of the market remains down. We’re in a bear market, and we will remain in that posture until current economic dislocations are honestly addressed, and solved.

Market valuations, adjusted for inflation, are currently higher than they were in 1929, 1966, 1987 and even 2000.

Chairman Greenspan

After expanding the U.S. money supply more than all previous Federal Reserve Chairman, Greenspan is now warning that large trade deficits and large Federal Government spending deficits could bring the U.S. economy to it’s knees. This is after he has provided the fodder for this potential disaster.

Here’s a quote from the objectivist written by Greenspan in 1966: “Gold and economic freedom are inseparable. In the absence of a gold standard, there is no way to protect savings from confiscation through inflation. Gold stands as the protector of property rights. If one grasps this, one has no difficulty in understanding the state’s antagonism towards the gold standard”. This prompted the Wall Street Journal to write last week “Mr. Greenspan has a complicated way of reconciling his job with his economic theories. In an ideal world, Greenspan believes there would be a gold standard and no central bank.”

Noble Lauriet Highman Minsky points out that stability leads to instability. He says that “The more comfortable we get with a given condition or trend, the longer it will persist. And when the trend fails the more dramatic will be the correction.”

Minsky is putting into clearer words what Greenspan is hinting at—if we do not get these current imbalances under control, our economy continues to face a disaster.

Conclusion

Let’s face it, most of us have never had it so good. Life in America is wonderful, and we’re blessed to be a part of what this country has accomplished the last several generations.

We will be best off by being happy with what we have and by being patient in waiting for the primary trend of the market to reverse itself. There are no conditions on the horizon indicating there exists a probability we will have either an economic boom or a nice expansion of the stock market for quite a few years to come.

Caveat Emptor!
George Rauch
November 29, 2004

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