The Age of Austerity Is Going to
Take a Lot Longer to Play Out

Why the age of austerity is going to take a lot longer to play out than many thought.The Dow Jones Transportation Average is now showing some real strength around the 4,500 level. This important index got hammered quite significantly. It dropped about 1,000 points since the beginning of July and you can see this in many of the railroad stocks that dropped like a stone when the broader market began to correct.

This index is only about 160 points away from achieving its 50-day simple moving average and this is another illustration of the resilience of the stock market. Several of the large railroad companies look like good values in this market and their yields are becoming quite attractive. Like the rest of the market, however, expectations for the future have been reduced. You’ll find that virtually all of the North American railroad companies have seen a reduction in Wall Street’s earnings estimates, this year and next. For quite some time, the railroad stocks were really leading the broader market. Now they are consolidating after the market’s correction.

It is difficult to be a buyer of stocks in this market, whether it’s for short-term speculation or long-term investment. The earnings picture is still looking decent for the bottom half of this year. But, without the expectation for growth in gross domestic product (GDP) in the first half of next year, it’s difficult to imagine much in the way of capital appreciation in share prices. This is why so many investors are sitting on the sidelines. There isn’t a lot of reason to be a buyer of equities, other than for yield if you’re a long-term investor.

I know lots of retirees who are not expecting much of anything from their equity holdings other than their quarterly dividends. Ever since the subprime mortgage meltdown and the stock market’s almost total collapse, a lot of individual investors have chosen not to participate in equities and this is why cash balances in brokerage accounts have been skyrocketing. Bonds and money market funds pay very little and the stock market’s been extremely volatile. It’s certainly no surprise that investors (and corporations) have been moving to cash. There’s not much out there other than investing in real estate and expected returns in this sector have also been dramatically reduced.

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The common theme throughout the recent financial crisis and the current state of things is debt. Whether it’s mortgage debt, personal debt, or national debt and deficits. Economies, countries and individuals are experiencing their own consolidation of finances and, without question, this will adversely affect economic growth in all Western economies. We very well could be in a slow GDP environment for the rest of this decade.

Importantly, I believe that policymakers should take a hands-off approach in trying to manage the economy and thereby let the system correct itself over time. The hands-on approach would be helpful in getting a firm hold on sovereign finances. Naturally, less debt-induced government spending would adversely affect Main Street economic growth. But, short-term thinking has only proven to put us in the current pickle that we’re all experiencing. It’s time for some thoughtful, long-run austerity to get the entire system back to solid footing.

Global stock market investors want short-term monetary action from central banks, but, at the end of the day, this kind of thinking is a big part of the reason why we’re in the current bind.