Hey, Fed – Where’s Our Silver Lining?

As I read the news and watch the markets, I’m struck by the yawning difference between what’s going on with the economy and what is happening with equities.

I know the worn out arguments.

People are buying stocks because they don’t have many choices. That’s fair, to some extent. The return on stocks (dividends, expected earnings growth) is higher than the interest paid on bonds.

Then there’s this one: Foreign investors moving to U.S. dollar-denominated holdings are driving up prices.

And my favorite: Stocks will keep going up because… they’ve been going up. I’m not sure how that makes sense, but I guess it follows some thread of logic.

There is some truth in each of these, but we need to keep one overriding factor in mind.

For years the silver lining has been growth in the equity markets. Every time we’ve discussed weakness in other parts of the economy, someone has always yelled: “But look at the markets!”

Clearly it’s true. Many people have made tidy sums over the past six years through investments… even if their paychecks have remained modest.

However, the silver lining is always in contrast to the cloud, and in recent years it seems as if people have forgotten the cloud exists. Not only is it still with us, but it’s growing more ominous by the day.

First quarter gross domestic product (GDP) was just released. For the first three months of the year, the U.S. economy grew at an annual rate of 0.2%. Note that this is the annual rate. The actual rate for just the quarter (one fourth of the year) was 0.05%, which is about as close to zero as you can get and still be positive.
This level of growth comes on the heels of our Fed printing almost $4 trillion, our mortgage agencies allowing home loans with a mere 3% down while conforming mortgage rates sit below 4%, and new car loans charging less than 3% interest.

With so many forces propelling the economy forward, we should be growing at 3% to 4% per year, not struggling to understand why we’re sitting close to zero. And yet, here we are, looking forward to another year of subpar growth — and it’s nothing new.

The Federal Reserve estimates GDP growth at every regular meeting, and they’ve been woefully wrong in their assessment for half a decade.

In late 2010, just as they launched the second round of quantitative easing (QE), the Fed projected 2011 growth at 3.3%, 2012 at 4%, and 2013 at 4% as well.

It didn’t work out that way.

GDP grew 1.6% in 2011, just a smidge below the Fed’s 3.3% expectation.

Still, the group was undeterred. In January 2012, they estimated growth at 2.5% for the year (lowering their previous estimate by almost half), thought 2013 would grow by 3.0% (a point less than previously thought), and pegged 2014 at 3.7% (just under the prior estimate).

Their 2012 figure of 2.5% was close. The economy grew by 2.3% that year. But subsequent years failed to live up to the lowered expectations. GDP grew 2.2% in 2013, and 2.4% last year.

Notice a pattern?

No matter what we’ve done to encourage lending and borrowing, economic growth remains anemic. This cloud is starting to blot out the bright light of the equity markets, which appear to have recently noticed that everything’s not sunshine and roses in the economy.

On a recent portfolio investment call at Dent Research, as usual we polled everyone for their opinion on the markets. The group includes Harry Dent, myself, Charles Sizemore, Lance Gaitan, Ben Benoy, John Del Vecchio, and usually Adam O’Dell, but he was on vacation that day.

As the rest of us went through our notes, I was struck by a common theme. We all noted that the markets continued to advance, but none of us could tell why.

At one point I asked everyone for a single answer on what could propel the markets higher. The only response was that the Fed could keep holding interest rates near zero a bit longer in the face of bad economic news.

That’s probably the best commentary of all on this cloud — the only positive is that the economy is so weak, even with all the stimulus and booster initiatives, that the Fed might not move short-term rates off of zero for another four to six months.

Pardon me if I don’t break out the champagne.

With six years of strong equity growth on the books without a significant correction, and the U.S. still suffering with weak growth, the chance of a break in the markets seems to grow with each passing day.

We’ve reiterated this point many times, but it bears repeating — be cautious. Now is not the time for added risk or speculation.

If you employ an investment process, pay close attention to your stops and sell signals.

If you don’t use a system, take the time to review your holdings to see if any pruning of gains is in order. When the current cloud starts to rain, it could quickly turn into a flood.

Rodney

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Categories: Central Banks

About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.