Market Watch - July 30, 2009
The stock market has improved dramatically. The market is in a bull posture, and if the government does the right things, the market may again become robust.
CURRENT POSITION OF OUR ECONOMY
The federal government is estimating a deficit of $1.84 trillion this fiscal year and a deficit of $1.25 trillion next year. Bank losses, funding automobile companies and economic stimulus will constitute the majority of that deficit. Theoretically, the banks and automobile companies will repay the government at a sizeable profit to the taxpayers. The stock market believes this, which is one of the reasons why the market has done wel l the last several weeks.
Many economists believe the recession is over and good times are around the corner. They might be right. Prices for goods and services remain reasonable. Adjusted real estate prices have caused housing to start moving again. Households currently have a lot of cash, and families continue to add to their savings. Businesses are leaner, and marginal employees have been removed. Businesses have recently increased inventory purchases, and they are beginning to add employees. State and local government are being cut back and made more efficient. All of the above motivates people to want to invest in the stock market again, and that motivation has contributed to the favorable recent action of the markets.
The market is now reasonably priced with price earnings ratios and dividend yields at average historical levels. For the market to obtain considerable future gains in price and dividends, a lot of things must go right:
| 1. | Government must continue to contract on the state and local level, and the federal government must dramatically reduce future deficit spending. Oddly enough, China is “insisting” that the U. S. reduce its deficit spending. China owns so many U. S. Treasury Bonds that they want to see the bonds stay20at prices close to what was paid for them. If the dollar continues to go down in value, China looses money, as do all foreign investors in U. S. bonds. Deficit spending causes inflation which is reflected economically in the lowering of the value of the dollar. Lower dollar values require bond yields to increase to make up for the loss in the value in the dollar. Dramatically increased interest rates will make it difficult for business to grow and prosper. |
| 2. | Housing must continue to improve. This represents about 2.5% of our GDP now, down from almost 5% historically. In dollars, housing is down roughly $350 billion. The housing market must continue to improve and ultimately return that $350 billion to our GDP. |
| 3. | Congress must insist that government expenditures come into balance with tax revenues. Deceased economist Milton Friedman wrote in his book Money Mischief, “Inflation is a disease, a dangerous and sometimes fatal disease that, if not checked in time, can destroy a society”. Northern Trust economist Paul Kasriel points out that total U. S. debt to total U. S. assets in 1955 was 40%. By 1985 it was 60% of total U. S. assets, and in 2006, total U. S. debt was 90% of total U. S. assets. The tremendous loss in the dollar’s purchasing power (inflation) is a result of the high build-up in debt. Individuals and corporations have improved their balance sheets rapidly, and they continue to build cash and decrease debt. |
| 4. | There must be fewer people on welfare and a more even distribution of income taxes in order for our economic recovery to be sustained. George Bernard Shaw wrote “A government that robs Peter to pay Paul can always depend upon the support of Paul.” Presently, 41% of the U. S. population works for government or receives transfer payments (all types of welfare) from the government. 144,000,000 people (44% of the U. S. population) pay no income taxes at all, and the top 25% of taxpayers, making $62,000 annually or more, pay 86% of all income taxes. |
| 5. | The banks must start lending again. Go vernment bailouts have added cash to banks in sufficient quantities so that banks are solvent and in position to lend money again. So far, banks are hording their new capital in case other toxic assets in their portfolios go belly-up. Banks need to get that new capital back into the spending stream by making loans. |
The above is a lot to expect. If we can get government to balance spending with revenue, as business and families have had to learn to do, the probability of a surging stock market improves.
PROBABLE OUTCOME
To carry on with disproportionate deficit spending, and continuing competition for capital by government, will yield sluggish economic conditions. Debt means risk. Debt requires a stream of future interest payments which reduce corporate and individual cash flow. “Business as usual” will yield a prolonged period of higher risk and lower returns reflected in little or no dividend growth. It’s hard to see a growing stock market under such conditions.
Lurking in the background of all of this are potential radical increases in taxes and radical increases in government spending from proposed changes in healthcare. For the market to continue to improve, these proposals making government drastically larger must not be implemented. The cost of our federal government must be reduced so that more fu nds in the marketplace are available for business to expand. Famed Austrian School economist Ludwig von Mises wrote “there is no means of avoiding the final collapse of a boom brought on by debt expansion. The alternative is only whether the crisis should come sooner as a result of voluntary abandonment of further debt expansion, or later as a final and total catastrophe of a collapsed economic system”. At this point, the economy is improving, but as von Mises points out, it is now critical that we as a nation work towards much less debt as a percentage of our total assets.
Absolutely nobody knows what our politicians will do. The cautious investor, therefore, should sit back, watch this unfold, continue to accumulate cash, reduce debts, and observe government actions. We are in a critical time with the interface of our economy and our government. English s tatesmen Lord Acton said almost 100 years ago “The danger is not that a particular class of people is unfit to govern. Every class is unfit to govern”. Limited government interference and action in an economy promotes growth. Invasive government, as we have today, frustrates economic growth because government is competing for capital in the marketplace with business.
Investors who must dabble in the stock market have many “A” rated stocks available selling well below their historic price-earnings ratios and paying dividends of 3.5% or more. This impressive list includes Abbott Labs, Altria, Automatic Data, Caterpillar, Home Depot, Johnson & Johnson, McDonalds, Minnesota Mining & Manufacturing, Pepsico, Philip Morris International, Proctor & Gamble, and Sysco Corporation. Notice that most of the above are companies with tremendous international exposure and opportunity.
Carpe Diem.
George Rauch
July 30, 2009
