The market is having a very good year so far. The S&P 500 is up 14.56% year to date.
Prices are being driven by our Federal Reserve policy, as noted in Barron;s 10-1-2012
http://online.barrons.com/article/SB50001424053111904414004578016363017457512.html?mod=BOL_hps_dc
“With the Fed providing easy money, Nordberg is betting that inflation will bolster growth stocks. “It’s all wildly inflationary, and stocks are real assets,” he says.
Volatility and change has been the rule this year. The echo of the financial crisis that began on 2/27/2007 according the Federal Reserve Bank of St. Louis (see http://timeline.stlouisfed.org/index.cfm?p=timeline) is still very much in investors’ minds. Sixty six months from the beginning and forty two months from the low price on the market and here we are. What has changed? Is the world a different place? Yes and no. Mostly no, no no.
The sun still rises predictably in the east and innovation marches on. Natural gas is booming and the price is quite low. Manufacturing is in recovery mode in the US and even housing prices seem to have bottomed. The military activities in Afghanistan continue and our political scene in the US is filled with the noise of a presidential year.
This is the most important election ever and it will have a dramatic impact on the future of the USA and the globe. Uh… huh, and so were all the elections before and those to come will also be called life changing.
It will be life changing when leaders elaborate on the actual mathematics of the US federal fiscal disconnect. The US now has $16t of debt outstanding. We are in the warm up of the era of the retiring baby boom. The strain on Medicare and Social Security is immense. In the midst of this demographic bubble, we continue to spend more on our military than the rest of the world combined. The Washington Post has provided recent perspective on the military budget http://www.washingtonpost.com/blogs/ezra-klein/wp/2012/08/28/defense-spending-in-the-u-s-in-four-charts/
More Money
“QE3” is the third wave of effort by the Federal Reserve to create conditions for improving the unemployment rate in the US through the creation of new money that is forced into the financial system through bond purchases.
The markets spent much of this year anticipating what the Fed would or would not do. Bernanke announced an open ended program of adding $40b per month of mortgage-backed securities. The central bank has also signaled the markets that near zero interest rates should continue into 2015.
These monetary policy actions will likely have significant impact on the value of the dollar although the adjustments may take much more time than markets expect. Globally the story is much the same. Aging population demographics in Europe along with complexity created by disparities among EUROZONE member nations has led to money creation in Europe via bond buying programs. Even China is joining the party and projecting lower rates to help stimulate their economy http://www.economist.com/blogs/graphicdetail/2012/06/focus-1
This environment of cheap money globally is complex and difficult to predict. Will we see growth and increasing employment, rising tax revenue and enhanced stability of government budgets? The fear is that money printing is a Pandora’s Box that cannot be controlled and will unleash inflation and further instability much worse than the problems that spawned the acceleration of printing presses around the world.
An Era of Crisis
The markets remain very volatile. It seems that the uncertainty of all the cheap money drives huge waves of buying and selling driven by headlines and words of central bankers. The current market has brought a new expression into common usage, “Risk-on-Risk-off”. As a market observer, I find it quite annoying listening to financial media commentators speaking of this concept. The expression seems quite useless. Reality is that when cash earns near zero, there is a huge incentive to put money to work. The fears of new stages of financial crisis type markets cause a significant hair trigger mentality. Money flows that are faster and faster due to technology advances and rapid fire trading further exacerbate these dynamics.
For the middle and long run, all of the volatility is nearly meaningless. Traders are not investors. They are trying to make money right now. Investors need to remember that we are trying to accumulate valuable equity stakes and generate future income and wealth.
Don’t Keep Your Money In Money
The dynamics of cheap money may be the most important thing that we must consider as investors. I liken the process to the “evolution” of money values. Over time, more and more money is created directly by central banks and then indirectly via private sector banks, insurance companies and a multitude of bond issuers (through the payment of interest).
There are many alarmist messengers in the market regarding this issue, most notable perennial presidential candidate, Ron Paul. You will be hearing more about this issue, and many voices will continue to demonize the Federal Reserve and call for the sacking of Ben Bernanke. I am not sure it would be better if a bottle of Coca Cola was still a nickel. You can pay as much as $2 for a soda, but it seems that living standards are much higher than the romanced times of the past.
Setting aside the possibility of a gold standard for money being created, what we need to anticipate as investors is that prices will rise to compensate for this acceleration of the devaluing of money. Prices of pizza, school supplies, gasoline, electricity, etc. will be rising. Prices of assets will also be going up.
This is where investors need to have patience and discipline. In the face of a volatile market, over time there is a big adjustment taking place. Equities, housing, commercial real estate, commodities and many types of assets should all adjust (upwards) in dollar terms. See previous comment https://adviceman.net/2012/01/08/market-comment-q4-2011/
Devaluing currency and possible inflation creates dynamics that the very low interest rates we see in our current environment are even lower than they seem. Holding cash, bonds or interest bearing accounts may be quite costly as the buying power of the Dollar, Euro and other currencies diminish. The risk of “negative interest rates” is very high is this environment.
This does not mean that investor wealth actually grows when held in equity vehicles, but it will be very important to keep up with the inflation in prices that may happen across the board. It has happened in the stock markets this year, but it is very short term. It has happened since the bottom on March 9, 2009 quite dramatically which is still less than a four year period. This will not be easy or happen in a straight line. The time for patient, long term thinking is now and always.
The focus will now go to laser concentration on the presidential election and huge year end issues commonly known as the fiscal cliff. Year end 2012 should lead us through more stubborn political positions on left and right. The US elections are unlikely to resolve much. Ultimately, the math will take over, and real negotiations will hopefully commence.