Lombardi: Stock Market Commentary & Forecasts, Financial & Economic Analysis Since 1986

Disconnect Between Stock Market and Economy Biggest I’ve Ever Seen

Thursday, March 14th, 2013
By for Profit Confidential

Disconnect Between Stock Market and EconomyBy looking at the stock market’s recent performance, one might think the U.S. economy has turned the corner and the worst is behind us. This is far from reality! The U.S. economy is fundamentally damaged, and since the financial crisis of 2008–2009, there really hasn’t been any real economic growth.

Even a novice economist will tell you: economic growth happens when general living conditions of citizens in a country improve; they are able to find jobs, they are able to maintain their standard of living, and they are able to spend and save.

Unfortunately, I see the opposite of this when I look at the state of the U.S. economy. Instead of economic growth, I actually see misery!

While politicians may rejoice over the recovery in the jobs market in the U.S. economy, it is still tormented. The job creation is unequal. During the financial crisis, 60% of the jobs lost were among the mid-wage earners. In the so-called “recovery,” 58% of all jobs created were in lower-wage sectors—retail and restaurant workers, mostly.

The year 2012 was the third year in a row that 40% of unemployed Americans were out of work for more than six months. (Source: National Employment Law Project, February 1, 2013.) In economic growth, there is equal job creation.

The middle class in the U.S. economy is suffering severely—its cost of living is going up, while income levels stay the same. Just look at the price of gasoline. The U.S. Energy Information Administration (EIA) reported that Americans paid $3.71 per gallon of gasoline during the second week of March 2013. (Source: U.S. Energy Information Administration, March 11, 2013.) It wasn’t too long ago when the same gallon used to cost less than $2.00!

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In January, disposable personal income (which is the money Americans have after expenses) decreased four percent in the U.S. economy. Yes, while the stock market makes new highs, real personal income for Americans had the biggest drop in 20 years. Does that make sense?

As the conditions in the U.S. economy remain unsettled, evidence of further economic deterioration is emerging. The Center for Retirement Research at Boston College forecasts that 53% of workers in the U.S. economy who are 30 years old or younger are unprepared for retirement. (Source: CNN Money, March 8, 2013.) If this group of workers doesn’t save and stays at work longer than normal, then those who are planning to get a foot in the door of the jobs market will have to wait for a long time.

The U.S. economy isn’t experiencing any real economic growth. What we do have is a poor job condition, increasing personal expenses, decreasing personal income, and relatively no personal savings. The suffering of the majority of Americans is being overlooked by optimism in the stock market. As time will soon show, the inequality between the stock market and the economy will eventually catch up with each other.

Michael’s Personal Notes:

One of the biggest debates amongst American economists these days is whether the Federal Reserve’s continued $85.0-billion-a-month expansion of the money supply is making the U.S. economy more vulnerable, as opposed to helping strengthen the economy. One of the main reasons the central bank took on quantitative easing in the first place was to revive the financial system following the housing slump. After a $3.0 trillion increase in the Fed’s balance sheet, should the central bank put the brakes on money printing?

Federal Reserve Governor Daniel K. Trullo said late last week, “Significant increase in both the quality and quantity of bank capital during the past four years help ensure that banks can continue to lend to consumers and businesses, even in times of economic difficulty.” (Source: Federal Reserve, March 7, 2013.)

While this may be good news, I am more concerned about what may be next—the “exit” of a monetary policy, which in the eyes of many has now gone on for too long. As noted above, through quantitative easing, the Federal Reserve has added a significant amount of assets to its balance sheet.

How will it decrease its balance sheet and bring it back to historical levels? On one hand, the idea is that the Federal Reserve can continue to hold the bonds it has bought until maturity. On the other hand, the option is to go out into the open market and sell the bonds it has accumulated.

While these options sound feasible, I see them as troubling. If the Fed sells the bonds it has in the open market, then the prices of bonds will collapse due to an increased supply. A simple rule of economics: when the supply increases, prices go lower. In addition, it could cause borrowing costs or interest rates to rise significantly if there are no takers for the bonds. On the other hand, if the Federal Reserve holds its bond purchases until maturity, such action may be taken as an indication that there are no buyers for the bonds, thus, the Fed is forced to hold onto them—this creates investor uncertainty, which is bad for any market.

What it boils down to is that the Federal Reserve may not have many choices when it comes to unloading all the bonds it has accumulated. As I have been saying in these pages, the longer quantitative easing continues in the U.S., the bigger the troubles down the road.

What I won’t be surprised to see is the Federal Reserve continuing its bond buying operation, because quite frankly, I’m not sure how many buyers of U.S. Treasuries we would have if the Fed was not in the market buying them.

So what’s an investor to do with all this uncertainty about what happens next with quantitative easing? No matter what the Federal Reserve’s next action may be, I continue to see gold bullion as a hedge against quantitative easing and an expansive monetary policy.

Where the Market Stands; Where It’s Headed:

The stock market is becoming severely overbought. My indicators show that the market is reaching a top, not starting a new bull market (as I have read from others). I urge caution with stocks.

What He Said:

“In 2008, I believe investors will fare better invested in T-Bills as opposed to the stock market. I’m bearish on the general stock market for three main reasons: Borrowing money in 2008 will be more difficult for consumers. Consumer spending in the U.S. is drying up, which will push down corporate profits.” Michael Lombardi in Profit Confidential, January 10, 2008. The year 2008 ended up being one of the worst years for the stock market since the 1930s.

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Michael Lombardi - Economist, Financial AdvisorMichael bought his first stock when he was 17 years old. He quickly saw $2,000 of savings from summer jobs turn into $1,000. Determined not to lose money again on a stock, Michael started researching the market intensely, reading every book he could find on the topic and taking every course he could afford. It didn’t take long for Michael to start making money with stocks, and that led Michael to launch a newsletter on the stock market. Some of the stock recommendations in Michael's various financial newsletters have posted gains in excess of 500%! Michael has authored and published over one thousand articles on investment and money management. Michael became an active investor in real estate, art, precious metals and various businesses. Readers of the daily Profit Confidential e-letter are offered the benefit of the expertise Michael has gained in these sectors. Michael believes in successful stock picking as an important wealth accumulation tool. Married with two children, Michael received his Chartered Financial Planner designation from the Financial Planners Standards Council of Canada and his MBA from the Graduate Business School, Heriot-Watt University, Edinburgh, Scotland. Follow Michael and the latest from Profit Confidential on Twitter or Add Michael Lombardi to your Google+ circles