“It is indisputable that our economy is stronger today than it was when I took office”- Barack Obama
Anyone who has paid attention to mainstream news this year would garner the impression that, economy-wise, everything in N. America is quite strong and rosy. Here is what we have been told:
● Growth is healthy and rising
● There are tons of good jobs out there and the picture gets rosier daily
● Low interest rates are great because housing is more affordable
● Corporate profits are up
● The stock market has risen for 6 years in a row which is a sign of economic strength
● Inflation is low and remains within the 2% target range
● The recent stock market correction is simply another buying opportunity
● Mark Carney did an excellent job as Bank of Canada Governor
With all of this great news heaped upon us, one could be forgiven for thinking that, after the 2008 financial crisis, we have come out of things so much better than before. Not so fast!
This week’s article will focus on all the things you are NOT being told about the economy, interest rates, the stock market, and housing.
From here we can form the basis of some intelligent investment decisions.
GDP growth has been steadily rising in both Canada and the U.S. Corporate profits have been rising as well. This should be a cause for celebration. However, we need to keep in mind that this growth has been stimulated artificially, through abnormally low interest rates and central bank money-printing. Central banks around the globe have made it a top priority to ensure that we do not experience a recession. To do this they have been interfering with the normal economic cycle, borrowing from future generations, heaping on more and more debt, to keep the party going. As John Mauldin aptly describes, after the 2008 financial crisis, the economy was on life support and needed the financial equivalent of morphine. Central banks were all too happy to provide that morphine, in the form of ZIRP (Zero Interest Rate Policies), QE (Qunatitative Easing), and TARP (Troubled Asset Relief Program). Basically they lowered rates, printed money, and used public money to buy companies that were on the verge of bankruptcy. And guess what, the policies worked (temporarily, anyway). Then when the patient (economy) began to show signs of health, and did not need the “morphine” stimulus anymore, we became addicted to it. The policies continued for years after they were needed. We have been following these easy- credit, easy-money policies for many years now, and it looks to be finally catching up to us.
We are continuously bombarded by messages telling us how fantastic this low interest rate environment is. “Look at how affordable mortgage payments are! Now you can finally buy a home!” the banks entice us. Low rates mean more of us can borrow more money. The sad part is that there are two major consequences to low interest rates. First, low rates cannot go on forever. There has to come a point where the consumer borrows to his/ her limit, and those at the margin (the poorest) can just barely make loan payments. What do you think will happen when rates start to rise even 0.5%? It doesn’t take a genius to figure out that more people will become unable to make those payments, there will be more bankruptcies, and our consumption economy will start to suffer. There is a second, extremely large group of people who have been suffering: Savers. All of those retirees who rely on bond and GIC interest have been completely crushed by low rates. Undoubtedly there are millions who have worked hard, saved all of their lives, and are seeing their savings dwindle quickly as a result of negative real interest rates (this occurs when your interest earned is less than inflation and you actually lose money every year).
Most people do not realize this, but by keeping interest rates artificially low, banks have been skimming billions upon billions of dollars of hard earned money from savers! Lower rates = more loans = higher bank profits. All at the expense of those savers who just want to retire with some semblance of comfort. It is truly unfortunate that so many Canadians see these artificially low rates as a benefit.
The Stock Market
It has been one heck of a party! Stock markets around the globe have essentially had an upwards run for approximately 6 years. Why has this occurred? Has it been through natural, organic business growth? A truly healthy economic recovery? How about Obama’s fiscal policies? Unfortunately the answer is no on all accounts. What has actually occurred is that low interest rates have forced many investors, who would otherwise prefer the safety and income of bonds, to venture out higher on the risk curve to bid up stock prices. In addition, the two magic letters called QE, have spiked the punch bowl to unprecedented levels. Basically central banks from around the world have been printing money like crazy. The levels have been so insane that the U.S has more than quadrupled its balance sheet since 2008! Ben Bernanke, former U.S. central bank chief, publicly declared that the central bank “has the market’s back”, meaning that, any time there is a scare in the stock markets, the U.S. will print as much money as necessary to provide more dollars to continue pushing stock prices higher. That is where the term “Bernanke Put” came from. Investors have realized that they could keep plowing more and more funds into stocks, because at the first sign of trouble, more money would be printed, and they would always be bailed out. This has caused today’s stock markets globally to soar constantly almost without pause. With high stock returns, combined with a safety net, who wouldn’t buy?
Let’s take a step back and look at who has really benefitted from this rise. Since the vast majority of stock market wealth is concentrated in the hands of the wealthiest 10%, the rich have benefited almost exclusively. The middle class and poor, who own commensurately less stocks, have been helped little if to any degree. Investment banks, and the wealthiest citizens, have government and central bank policies to thank for the huge increase in wealth disparity over the past 6 years. Thanks Obama, Bernanke, Carney, Draghi, et al!
I have heard anecdotally that approximately 50% of the economy is tied to housing and real estate. This makes sense. From raw materials, to builders, lenders, agents, home furnishing stores, etc, it is easy to comprehend the pervasive effects the housing market can have on our economy. Post-2007, the U.S. experienced a major housing bubble which burst, and basically reset the values closer to where they normally should be. My main concern lies not with the U.S. housing market, but Canada, as we did not experience the bubble bursting like our southern neighbours. In Canada, housing prices have simply kept climbing, with no end in sight. Our former central bank head, Mark Carney, also instituted a low rate policy. The effect of this was to, of course, stimulate the housing market artificially. Rates go lower, which increases market participants. More buyers means home prices rise. Rising prices mean people suddenly find themselves with additional home equity. What do many do as a result? They take out a HELOC, or homeowner’s line of credit, and use that cash to renovate the kitchen, put in a hot tub, and spend more at home stores. The home store’s profits go up commensurately, and continue to sprial. Everyone feels like they are in heaven because prices keep going up. Do you see the problem here?
There are a number of economic reports citing the Canadian housing market being currently approximately 25% overvalued as compared to global norms. The policies of Mr. Carney have served to pump up our housing market so that it has the distinction of being the world’s most expensive as compared to GDP. So what happens when rates do start to rise (they can’t go much lower) and the music stops? Will there be enough seats for everyone at this game of economic musical chairs? One thing is for certain: bubbles do not keep inflating forever, and the larger they get, the bigger the burst.
The Economic Cycle
There is an economic school of thought called Keynesianism, inspired by the research of Sir John Maynard Keynes (1946). Keynes had the viewpoint that the economy could be successfully maneuvered, through adept monetary policies, in order to avoid downturns. If the economy got too heated, a central bank could raise interest rates to cool things off. If we experienced a slowdown, stimulus could be created, via temporary money printing and rate lowering, and prop the economy back up again. In theory this sounds like nirvana. Continuous, slow and steady growth, without the nasty downturns of the business cycle? Sign me up!
Unfortunately this theory has proved to be difficult, if not impossible, to apply correctly in the real world. Former U.S. central bank head Alan Greenspan attained almost rockstar-like status, and many millions in personal income, by stimulating the U.S. economy to extremes during the Bush administration of the 2000s. This era’s version of Greenspan was Ben Bernanke, who, along with economists such as Paul Krugman, believed in the “super-stimulus” programs described above. They believe that the U.S. economy will turn out okay, as long as they simply keep feeding the beast by printing money, and keep rates low. The truth is that today’s monetary policies are experiments that have never been attempted, in the history of the world, on such a grand scale. Central banks are borrowing SO MUCH money to keep their economies from experiencing a downturn, the best description would be to refer to the infamous Wile E Coyote, who always has his eye on that road runner. Even after he has gone off the cliff, he keeps on going, gaze forward, until he doesn’t realize that terra firma is no longer below. The only thing left is to hold up a sign (perhaps “Bye, Bye”?) before he plummets to the ground far below. It is altogether possible that the economic and financial underpinnings of our economy have gone “off the cliff”, so to speak, and our wise central bankers, and Keynesian economists, are 100% gaze forward, eyes on the prize, let’s cross our fingers and hope this works. Just don’t look down and everything will be all right. Yikes.
(Note- It is altogether possible that I have been reading too much ZeroHedge, but I don’t think so, this is about as accurate a picture of reality as I can paint)
Good News: There Are Things You Can do to Prepare
As an investor, today’s environment looks to be quite challenging. However, I believe that the best way to protect your investment portfolio from the potential coming storms is to be prepared in advance. A few tips:
- Keep some powder dry- The last time we faced an economic/ financial crisis, an unprecedented buying opportunity was created, leading to the past 5+ years of stock market gains. By keeping some cash handy, versus being fully invested in stocks, you may be able to take advantage of a crisis by buying when there is “blood in the streets”.
- Diversify away from strictly stocks, bonds, and mutual funds- Investing in areas such as gold (see my article here), and private offerings (see ideas here), can serve to insulate your portfolio from the stock market rollercoaster, and combat low bond rates.
- Ensure you have adequate safety reserves- See my article here on preventing investment mistakes which describes this category.
By establishing a proper investment game plan, in advance, you can weather most economic and financial storms, and possibly even benefit if your portfolio is positioned properly.
For more information on investment concepts, used by the professionals to maximize risk vs. reward, download my free Guide to Understanding Real Assets, located to your right.