Whatever Happened to the Business Cycle?

Stock MarketThe distortion that’s now taking place in the U.S. economy is unprecedented. There are artificially low interest rates, companies that should have gone bankrupt were rescued with taxpayer debt, and the Federal Reserve has basically become an instrument for Wall Street’s fulfilling its desire for short-term gains over all else. I fear the conclusion to all of this.

No other large economy in the world is more able to right itself after a shock than the U.S. economy. And no other stock market is able to recover so quickly. This has been proven time and time again, but the key to this recovery is to allow bad businesses to fail, and to let better-managed businesses acquire and reinvent the good pieces. The U.S. economy is based on free enterprise, but it isn’t so free anymore. It’s worth noting, however, that Wall Street is the biggest champion of the Federal Reserve, even if it doesn’t want to admit it. Whether you’re an institutional investor or a short-term professional trader, it’s pretty difficult to argue against easy monetary policy and a massive effort to reflate the U.S. economy by printing money and creating artificially low interest rates. The stock market couldn’t be happier.

I can’t recall a time when the Federal Reserve was more accommodative to Wall Street. The subprime mortgage crisis was unprecedented, and so was the huge exposure by many of the world’s biggest financial institutions. Yet, it doesn’t seem to me like there’s a level playing field anymore. The fervor with which the Federal Reserve is trying to manipulate the short-run business cycle of the U.S. economy is incredible. Perhaps it’s all Ben Bernanke knows how to do.

The U.S. economy has been producing mixed economic news for quite some time. While the employment situation isn’t getting any better, the housing market (according to the data) is slowly recovering. Stock market investors know we’re in a slow-growth environment for the next several years, so they are focusing on other things like dividends and monetary policy. (See “Stock Market Defies Earnings By Going Up—Four-year High in Sight.”)

I argue that most corporations have been doing their part—managing their businesses conservatively with so much uncertainty. The stock market has rewarded these businesses, and many of these companies are trading at their 52-week highs. Right now, the stock market doesn’t particularly care about the headwinds that are coming next year; all the stock market cares about is getting through the fourth quarter.

Many of the stock market’s leading positions recently turned higher after selling off a bit towards the end of August, which is shown in the below chart of International Business Machines Corporation (NYSE/IBM), which we all know as IBM.

Chart courtesy of www.StockCharts.com

The Federal Reserve can’t do anything more to help the U.S. economy or the stock market, for that matter. I think central bank and stock market investors need to have more patience to let the business cycle play out on its own. Of course, this will never happen; everyone wants short-term gains now. I believe there is an underlying strength in the current U.S. economy, but I doubt it can return to the days of four- or five-percent annual growth until this enterprise system is allowed to become truly free again.