Market Watch - June 28, 2010
The problem with "Market Watch" recently is there is not really very much to "watch" in the market. The bond market continues to go down, causing interest rates to increase; stock markets are struggling in a trading range, with Wall Street doing everything it can to keep it above 10,000 points; and the commodities markets continue to go down in price, except for precious metals like gold and silver.
The Federal Reserve System was founded in 1913 with the promise to level out deterioration in the markets as we're seeing today. Let's see how well that has worked:
| • | The Dow high in 1890 sold off 64%, and it took 15 years for the Dow to get back to even; |
| • | The Dow high in 1906 fell 48%, and it took until 1916 for the Dow to get back to even; |
| • | In 1913 the Federal Reserve System was founded to level out these down cycles in the market, and put an end to them. |
| • | In the Fed's first "at bat", the 1916 high fell 50%, and it took until 1925, 9 years, for the Dow to get back to even; |
| • | The high of 1929 witnessed a Dow fall of 89%, and it took 26 years, until 1955, for the Dow to get back to even; |
| • | The high in 1966 fell 38% and it took until 1973, 7 years, for the Dow to get back to even; |
| • | The 1973 Dow high fell 45%, and it took until 1983 for the Dow to get back to even; |
| • | 14,164 points on the Dow in 2007 has so far sold off 54% to 6,547 points. There is no telling how long it will take to obtain the 14,000 point level again, or that the market could breach 6,547 points. |
What's important here is to notice that the purpose in founding the Fed in 1913 was to "level out" these decreases. It has not worked. The Fed is comprised of a secret society of bankers and top government officials; a closed group of men and women who are unaccountable to the voting public, yet they have the power to issue the nations currency. A regulatory policy should make it possible for a bank to fail without endangering the rest of the system. The Fed's solution, however, to all of our economic problems, is to always increase the size of government through additional debt, additional regulation, additional rules, and more taxes.
The Fed is not only unnecessary, but it has proved to be harmful by not doing the simplest things in terms of regulating banks:
| 1. | Ensure that banks have sufficient capital; |
| 2. | Proprietary trading by banks, who are risking depositor's money that is insured by the Federal Government, should simply not be allowed. |
The lack of rules governing those two simple economic thoughts is what has created our current problems. Had the banks acted like banks and provided capital for growth, instead of providing loans to Wall Street to speculate with, we would not have these problems. Instead, the Fed, by creating artificially low interest rates, fueled speculative borrowing, something that has happened throughout history when low interest rates are not established by free markets.
Question: How many years until this market recovers and reaches the record 14,164 points?
Answer: The question cannot be answered without knowledge of future government borrowing, the cost of the Obama Health Plan, and future tax increases. The answers to those questions dramatically influence the economy's cash flow. At current market price earnings levels on the Dow Jones Industrials, to get back to 14,000 points would require a doubling of earnings on the Dow stocks. The doubling of earnings on the Dow stocks will obviously happen, but how long will it take? A doubling of corporate earnings in five years would require a 15% compounded annual growth rate. That's unlikely. A 10% compounded annual growth rate under these conditions would be very good, and that would take seven years.
Question: So in about seven years, at 10% growth, the market can get back to 14,000 points?
Answer: That's true, but only if the current price earnings ratio exists at the end of seven years, and 10% compounded annual growth in earnings is sustained. The average historical price earnings ratio on the Dow Industrials is 14.5 times earnings. If the market reverted to that average, the market would not reach 14,000 points until the ninth year.
Question: If the Fed is responsible for all this public debt buildup, and responsible for rescuing banks "too big to fail", why can't we just put a stop to it and end the Fed?
Answer: It would literally take an act of Congress. It has been a contentious subject for almost 100 years. The Constitution in Article I, Section 8 says, "The Congress shall have the power to borrow money on the credit of the United States, to coin money and regulate the value thereof". Right there is the authority to audit the Fed, and to terminate the Fed. A request to audit the Fed is in HR bill 1206, in the House, and S604 in the Senate. All of that was supposed to be incorporated into the "New Monetary Reform Bill"; however, it has so far been removed.
We shall continue to have a small group of people secretly control the money supply of the United States until the public educates themselves to understand that the Fed is one of our economies big problems. From an historical point of view, The Constitution was written the way it was to avoid the consolidation of money power among a few men. Throughout history, a few men have grabbed the reigns of each country's money supply, and the Founding Fathers knew it. They also knew that if the control of the country's money supply remained with the people, that money would remain safe. Individuals are better stewards of their money than the government is of our money.
Question: How could we be better stewards of our own money?
Answer: Until the Fed confiscated our gold in 1933, each amount of paper money in our possession was 100% redeemable in silver or gold. The money supply, therefore, was controlled by the people through their ownership of money represented by gold or silver. All paper money was redeemable in "specie" (gold & silver). Coincidently since 1933, several significant economic conditions have occurred:
| 1. | The size of all government in our country has gone from 10% of GDP in 1933 to 35% of GDP today; |
| 2. | The dollar will buy only 1/25th of what it did in 1933; and |
| 3. | There was an ounce of gold for every 20 paper dollars in circulation. Now, one ounce of gold in our vaults is represented by more than $75,000 dollars in circulation!!! |
| 4. | In 1933 there was no significant public debt. Now, every family of four's share of the public debt is $148,000. |
George Washington wrote "Paper money has had the effect in our state that it will ever have—to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice."
Conclusion
Judicious investors should remain in cash. Purchasing as much silver and gold as comfortable will lower risk toward the continuing reduction in the purchasing power of the dollar. If one has an itch to get more involved in the stock market, there are some excellent companies yielding more than 3% that are selling at low price earnings ratios. They are Abbott Labs, Altria Group, Automatic Data Processing, Coca Cola, Johnson & Johnson, PepsiCo, Phillip Morris International Inc., Proctor & Gamble, and Sysco Corporation. Each of these companies have a 12 year record of consistently increasing both earnings, and dividends to stockholders.
For those investors concerned that cash earns so little, it's important to remember that we are in an economy of deflating prices. As we hold cash in a deflating economy, the value of our cash increases because each dollar will purchase more goods. At some point inflation will take over again.
These are times for cautious investors to remain liquid. Not only can liquidity make sleeping easier, but liquidity can help us "buy right" if we see signs of improving opportunities. Right now, however, the same numbers of people are employed in our economies that were employed 10 years ago. And, the Dow Jones Industrials is where it was 10 years ago. We may continue to move backwards economically before any serious turnaround develops.
Caveat Emptor
George Rauch
June 28, 2010
