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Spengler

The Stock Market Rally That Makes You Poorer

May 1st, 2013 - 1:12 pm

Update: Stocks are up big on today’s employment report. In fact, Americans worked less in April than in March: multiply the increase in payrolls by the decline in hours worked, and the total number of working hours fell. Almost all the increase in employment was in retail, hospitality and temp agencies, and probably reflects employers spreading the work around a larger number of workers working fewer hours in order to save on health benefits.

Just after Obama’s re-election we heard Republican leaders explain that Obama had just gotten lucky — the economy was in the recovery phase of a normal business cycle, and Obama caught the right wave. As the stock market rallied through the first four months of 2013 and regained its old peak, the story seemed credible — until a couple of weeks ago, that is.

We’ve had one depressing economic report after another. Employment is barely growing, according to the ADP survey, which showed just 119,000 new jobs created in April and 118,000 in May. The April purchasing managers’ index for manufacturing fell sharply from 54.6 to 52.1 (50 is dead in the water).

The Shadow Government Statistics website calculates the true unemployment rate — the proportion of the working-age population that can work but doesn’t — at 23%. That includes so-called “long-term discouraged workers” not included in the labor force. Even the government’s own broad measure of unemployment still stands at almost 15%, twice the pre-crisis level.

On a GDP basis, the economy grew at an 0.8% rate in the fourth quarter of 2012 and at a 2.5% in the first quarter. That’s just 1.5% without counting inventories. Investment in industrial equipment actually fell during the quarter. It’s an economy that is flying barely above stall speed.

No, Obama didn’t win re-election because the vote happened to occur at the cusp of a normal business cycle recovery. The economy really is that bad. So is Obama. Sadly, so was the Republican ticket.

Why is the economy so bad? According to the usual chatter, it’s because payroll taxes went up and took $140 billion out of personal income during the first quarter. But another big category of personal income — receipts on assets — fell by $125 billion, a hit to personal income almost as big as payroll taxes. And almost all of that was due to lower dividends. It turns out that companies are paying a lot less cash out to stockholders. The S&P 500 dividend per share fell from about $9 to about $8 during the first quarter, and the GDP data indicate that drop occurred throughout the corporate world.

Another sign of economic weakness is that the sales of S&P 500 companies fell by 5% during the quarter. Profits per share, though, were higher. How is the stock market managing to levitate above a busted economy, where the sales growth of top companies can’t even keep up with nominal GDP? Part of the reason is leverage.

The weighted average Return on Investment for the S&P 500 is slightly over 11%, and the cost of medium-term BBB borrowing (the average rating for the S&P 500) stands at just over 3%, thanks to the Fed’s quantitative easing program. In sectors where cash flows are annuity-like, e.g., consumers and utilities, it makes sense for companies to issue record amounts of bonds and buy back their own shares. That helps explain why earnings can continue to grow, at least modestly, even though revenues appear to have fallen by nearly 1% during the first quarter.

Here’s a simple example. Suppose you and a partner jointly invested $100,000 in a business that earns $10,000 a year. You each have $50,000 in capital, and take out $5,000, for a return of 10% a year. If Ben Bernanke will lend you money at 3% to buy out your partner, you will now make $10,000 on your capital of $5,000, minus the interest expense (3% of $50,000, or $1,500). You earn $8,500 net on a $50,000 investment, or a 17% rate of return.

You would do that trade all day if you could. Thanks to the Fed, large U.S. companies can, and do. The cost of BBB-rated bonds (the average credit rating of the S&P 500) is at an all-time low of 3%. And the average return on investment for the S&P 500 is around 11%. The actual numbers are not much different from the example I just gave.

Graph of BofA Merrill Lynch US Corporate BBB Effective Yield

Graph of BofA Merrill Lynch US Corporate BBB Effective Yield. Click to enlarge.

There’s a catch, of course. If you take on debt to buy income from a business, you could get into trouble if business profits drop. That’s why companies play this leverage game in sectors that have reliable income streams, for example consumer staples. Below, we see the performance of the Consumer Staples ETF (XLP) against the Industrials (XLI) and Technology ETF’s. Stable sectors with annuity-like cash flows — consumer, utilities, and health care — soared during the first quarter, while riskier sectors languished.

Chart forConsumer Staples Select Sector SPDR (XLP)

There’s another catch. It’s so easy to make money by levering up corporate balance sheets that there’s no incentive to invest in new plant and equipment. Bernanke’s cheap money policy was supposed to reduce returns to cash and bonds and force investors to take risks in real assets. It hasn’t worked out that way. It’s only encouraged investors to apply more leverage to existing assets. No investment, no jobs. That’s part of the reason employment refuses to recover. Another is Obamacare, which drastically increases the cost of new hiring for small and medium-sized businesses.

The rally is making Americans richer on paper but poorer in terms of income. Suppose you owned a portfolio of BBB-rated corporate bonds yielding 4.4% in June 2011, and sold it to buy stocks. Your stock portfolio would have gained 20% since then. If you sold the portfolio to buy bonds at the present yield of 3.2%, you would be able to buy 20% more bonds, so your portfolio would yield 1.2 X 3.2%, or 3.84% — less than you received before. In terms of income, you lost money by selling bonds to buy stocks back in June 2011. In fact, you would have lost on a current-income basis if you sold bonds to buy stocks on almost any day during the past five years.

Fed easing hasn’t brought about recovery. Government spending won’t bring about recovery. Supply-side incentives to investors (lower corporate and capital gains taxes in particular) and regulatory rollback, starting with Obamacare, are the only way out of this morass.

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Top Rated Comments   
"Supply-side incentives to investors (lower corporate and capital gains taxes in particular) and regulatory rollback, starting with Obamacare, are the only way out of this morass."

Sadly, none of the above will be attempted until the socialists are out of office.
1 year ago
1 year ago Link To Comment
All Comments   (82)
All Comments   (82)
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the theme of the falling dolllar ended in 2011. Since then the dollar has been basing.
http://www.tradingeconomics.com/united-states/currency

My wag is that the next secular move for the dollar is up because rapidly rising US oil production and reserves.
1 year ago
1 year ago Link To Comment
When money is created from "nothing" by the tiny group of very very few in the Fed and Treasury (not to mention the Norkos) it flows preferentially to established players, and forms in huge impoundments of the very wealthy, the bigger the impoundment the more able it is to capture more of the stream of new money. True wealth is not created, for the true Wealth of Nations is only grown by many hands, directed by many minds.

Such a dynamic, that of the trapping of the paper wealth in ever fewer hands, in ever larger impoundments might happen in a financial culture that was honest perhaps, but it is hard to see how, as fiat money is patently dishonest, every new dollar is a theft by dilution of the other dollars already created. Most usually, and perhaps always, the dishonest rise to the top, controlling impoundments and flows.

The big gobble the small. For example Quartz today reports: "It’s time to say “goodbye” to very small banks", http://qz.com/80912/its-time-to-say-goodbye-to-very-small-banks/
1 year ago
1 year ago Link To Comment
I think that had more to do with dodd frank than qe1-4
1 year ago
1 year ago Link To Comment
My friend Steve sent me the following email that indicates a possible math error that would lead to the opposite conclusion of Mr. Goldman. Here it is:

this writer made a HUGE mistake in his sample calculation: first, typo from 50k to 5k, but most importantly, he only deducted the interest expense but forgot about the debt expense (principle repayment), which would have reduced his returns to 7.62% - assuming the 4.4% corporate bond rate he mentions - instead of the claimed 17%. Since according to his own admission the SP yields 11%, you would have been better off NOT to use leverage to buy out your partners, since your overall return would have decreased by 3.38% (11-7.62).

Said differently, the stock market did rise because of cheap money by the Fed but not for the reasons he mentioned. It was simply the money flow of risk free assets - T bills - flowing into risky assets (SP 500) that pushed the prices higher...After all the $$ won't stay in bonds due to abysmal - below real inflation - rates of return, and it can't go to declining gold and there is only so many apartment buildings you can buy..
1 year ago
1 year ago Link To Comment
I used the term yield for 7-year BBB's. Principle doesn't come due for 7 years. There is rollover risk at the 7-year horizon, to be sure, but no-one in this business worries that far out.
1 year ago
1 year ago Link To Comment
The note below is from my friend Steve who indicates a possible math error in David Goldman's calculation that would reverse his conclusion. Here it is:

this writer made a HUGE mistake in his sample calculation: first, typo from 50k to 5k, but most importantly, he only deducted the interest expense but forgot about the debt expense (principle repayment), which would have reduced his returns to 7.62% - assuming the 4.4% corporate bond rate he mentions - instead of the claimed 17%. Since according to his own admission the SP yields 11%, you would have been better off NOT to use leverage to buy out your partners, since your overall return would have decreased by 3.38% (11-7.62).

Said differently, the stock market did rise because of cheap money by the Fed but not for the reasons he mentioned. It was simply the money flow of risk free assets - T bills - flowing into risky assets (SP 500) that pushed the prices higher...After all the $$ won't stay in bonds due to abysmal - below real inflation - rates of return, and it can't go to declining gold and there is only so many apartment buildings you can buy..
1 year ago
1 year ago Link To Comment
Mr. Goldman, I think the primary problem is regime risk, not tax rates. Nobody knows what crazy destructive regulation or executive order the Obama administration will do to just to fire up their base for political gain. Large business focus is on working within the current system and surviving until 2017, not growth. Small business focus is staying below the radar and avoiding getting caught as they do whatever it takes to survive.

After Obama, the best stimulus would be a complete repeal of the Patient Protection and Affordable Care Act. Kill it dead! The next would be a law that declares that carbon dioxide is not a pollutant regulated by the Clean Air Act. Rather than directly reduce long-term capital gains tax rates below 15%, I'd allow investors to adjust the cost basis for inflation. I'd also sell federal properties and land to pay off debt, soak up some excess money, and move this property to productive use. Make those law changes early in 2017 and the economy would grow rapidly.
1 year ago
1 year ago Link To Comment
George B, we need regulatory rollback as well as tax cuts. I don't knoww hich is more important so I want to do both. Ideally capital income shouldn't be taxed at all (you get capital only by earning ordinary income which is then taxed), but we won't get there any time soon.
1 year ago
1 year ago Link To Comment
This is completely, entirely off your posted topic, but entirely within your realm of expertise, so you can scrub it if you like, but I would appreciate an answer.

I'm not up on music, or its effects on people. I just read something about how music moderates brain growth for boys more than girls? Like, it's measurably neuro-protective against the major mental illnesses? Not just "the mozart effect" for babies- but in neural pruning, and structuring. And then something wtih math?

What do you make of it? I know my math-iest kid is the most musically aware, but that's an anecdote, not a piece of evidence.
1 year ago
1 year ago Link To Comment
I don't know much about neuroscience. I'm skeptical about broad claims of this kind in general.
1 year ago
1 year ago Link To Comment
Music (and art) is in the right side of the brain, the creative side. Women generally dwell there. Men focus on the left side, so music develops the other side. That creativity allows for greater use of the right side. It allows greater intuitive leaps, inspired thinking.

Math is on the left side, which is why men are generally better at it. Math teaches logical process. Lots of women suck at math, and so, suck at thinking. Think of the stereotypical, gum-chewing bimbo, and you'll get this.

So, boys need to be pushed into arts, and girls need to be pushed into math, in order for them to have balanced brain function.
1 year ago
1 year ago Link To Comment
Nice article, David. I wonder, though, how much is coming to the American stock market from Europe and China, since definitely it looks like they are sicker than we are.
1 year ago
1 year ago Link To Comment
China's still growing at over 7%. How you define sicker? Europe is very sick, to be sure. Data on foreign purchases of US securities are available here:
http://www.treasury.gov/press-center/press-releases/pages/jl1897.ASPX
1 year ago
1 year ago Link To Comment
David, thanks for the link. As far as China I was refering to the ongoing environmental damage and long term financial problems. One thing: do you trust Chinese governmental statistics? All the best
1 year ago
1 year ago Link To Comment
Not particularly, but I don't think they are so far off as to change the conclusions.
1 year ago
1 year ago Link To Comment
Please no history lessons on how supply side worked before because there are history lessons on how cheap money and high public spending has worked also. It should be analyzed under the current factors we face.
1 year ago
1 year ago Link To Comment
" there are history lessons on how cheap money and high public spending has worked also"

Where?
1 year ago
1 year ago Link To Comment
World War II was public stimulus on hyper drive and the 1980s boom was partly financed w cheap money how else do u explain thehigh inflation n massive devaluation of our currency during that period.
1 year ago
1 year ago Link To Comment
the 1980's were fueled by cheap gas.
1 year ago
1 year ago Link To Comment
The economic recovery did not begin during WWII, but in 1947-8 after repeal of many parts of the New Deal, in fact, the post-war recovery was considered to be paradoxical in that we were supposed to have had a recession. Interestingly enough, Coolidge and Harding pulled off the same stunt. Both of these examples are closer to supply-side economics than anything else. The 1980's was pure supply-side. Boy, are you stupid.
1 year ago
1 year ago Link To Comment
Lmao, the clowns never sleep. Wwii era unemployment levels were very low DURING THE WAR. The post war boom was primarily the result of war bonds coming due which tranferred money from govt to private hands and the rise of military Keynesianism which Reagan used to his benefit. Have u ever seen the levels of government spending during Reagan years simpleton u d be surprised how high it was of course that contributed greatly to economic growth for without it they could never imagine cutting taxes would work what the hell would they invest in if demand wasn't being stimulated idiot.
1 year ago
1 year ago Link To Comment
Today, the most major component of our domestic economy is reliant on consumerism and consumer credit and that proves unsustainable evntually. I'm happy to see you've looked and analyzed the Reagan era economics data's and its following impacts. Very similar to the '20s and its following years and decades.
1 year ago
1 year ago Link To Comment
Yes, conscripting young men into the service of the government to kill and die and then seeing a statistical reduction in "unemployment" is a wonderful feature of aggregating economics. One must question the validity of any system that sees economic benefit in conscription, death, destruction and waste of resources and scarcity. There was no prosperity, yet we are told so often that this war caused an economic recovery. But anyway, it must be true. Why, that worked so well, I for one say we should have another massive war! And, let's not forget the preparation for the alien invasion. It should be super stimulative. We should also build some cities somewhere to stimulate demand. We can figure out later whether anyone really needs them or can afford to take them or can afford to operate and maintain them. Because demand is what matters, not production or capital investment.

Kind of a lot of jumping around there. The Keynsians fretted about and predicated a post-war bust. They were wrong. That should be admitted easily.
1 year ago
1 year ago Link To Comment
It would be nice if you could expand on the supply side incentives concept as a solution because somehow I fail to see how privatee investors would be more incentivized to invest if they had more money left over from lower taxes and regulation burdens than from the cheap money they now get through current monetary policies. I don't see the connection or why the incentive is so different since I can also "buy out" my partner if fiscal and regulatory policies allowed me to keep extra money and as a bonus I wouldn't have to pay any interest on it but why would I be compelled to invest instead? Maybe there's a reason why the idea was finished so abruptly.
1 year ago
1 year ago Link To Comment
It's a good question. In fact, the Reagan recovery combined tight money and fiscal incentives. The Fed should in fact raise interest rates in the context of supply-side fiscal and regulatory incentives.
1 year ago
1 year ago Link To Comment
The reagan recovery was fueled by cheap gas. The saudis panicked when they saw the first US alternative fuel push. At that time they had a lot of surplus capacity. so they pumped like crazy and drove the price of oil down to 10-12@ gallon. This lit the fire under the reagan recovery and killed the first US alternative fuel push.

The Saudis don't have excess capacity now. and they need high prices to pay for their bloated government. so their control over oil prices is slipping.

imho the current revolution in energy production--will wind up by 2016 shoving the stock market over 20,000, significantly shrink the US government deficit and make the Obama look good despite his best efforts to kill the economy and stock market. In short Obama will benefit from the effects of ongoing technological revolution in much the same way as Clinton did in the late 1990's.
1 year ago
1 year ago Link To Comment
Not a friendly question around here. :)
1 year ago
1 year ago Link To Comment
MEMO
To: Economists/Politicians and Policy Reporters

Please be advised that the 'Markets' (Stock/Bond/Futures/Money) are NOT the economy! The economy is 'MAIN STREET' not 'Wall Street'.

Thank you
The Taxpayers
1 year ago
1 year ago Link To Comment
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