The economic black hole between the equity markets and the man on the street has never been greater. Earlier this month the media trumpeted about the all time highs in the Dow Jones Industrial Average. The President commends Congress for creating policies that “put Americans back to work,” and points to unemployment levels that are 25% below their 2009 peak. Meanwhile NBC News publishes the results of a new study, which states that four out of five of us will, “struggle with joblessness, near-poverty or reliance on welfare for at least parts of their lives.” Please bear with the following few paragraphs as we discuss the social issues that we all feel and use some correlational analysis to come up with a trading plan.
Anecdotal evidence of the government’s failed economic bailout plans to help the working class and small businesses abounds. Finally, we have some research that quantifies where TARP funds went as well as how much of the stimulus reached its intended target. We suggested five years ago that the major banks who were deemed, “too big to fail” were more likely to sit on the funds they received in order to shore up their own loan to equity ratios than they were to make those same funds that had been ear marked for small business creation and maintenance available to them.
The best summation of these events comes from John Mauldin, a republican economist from Texas. “We are watching the Fed employ a trickle-down monetary policy. They hope that if they pump up the banks and stock market, increased wealth will lead to more investment and higher consumption, which will in turn translate into more jobs and higher incomes as the stimulus trickles down the economic ladder. The kindred policy of trickle-down economics was thoroughly trashed by the same people who now support a trickle-down monetary policy and quantitative easing. It is not working.” Mauldin’s condemnation of trickle down economics is especially telling given his own personal background.
The government bailed out the owners of the large banks and their related business entities. Warren Buffet’s Berkshire Hathaway is a good example. When the financial crisis set in Mr. Buffet, who already owned a considerable position in Goldman Sachs, doubled down as the stock hit the skids. He was betting that the Goldman was, “too big to fail” and that the government would bail them out, which they did. Goldman Sachs received $10 billion in TARP aid. Berkshire Hathaway stock is 10% higher now than before the collapse and is up approximately 30% this year. The point is that those with equity ownership and the resources to increase their equity ownership by using the Federal Reserve as a backstop profited handsomely. Unfortunately, a Gallup poll shows that the percentage of Americans owning individual stocks and securities is at its lowest level since 1999 and has declined by 13% since 2007.
Human nature is a terrible trader. The scarcer something becomes, the more we want it. The more that’s available, the less we want it. When stocks were cheap, we were scared. We as individuals are never, “too big to fail.” Collectively, we rarely succeed. This is evidenced by the recent run up in margin buying, which just hit a new all time high. Margin buying is akin to buying stocks on leverage. Currently, investors are only required to put up 50% of the face value of a stock and the brokerage house, “loans” you the balance. The last recent highs were 2000 and 2007. Ring any bells? This is a significant indication that individual investors are doubling up at the top to catch what’s left of the rally they’ve missed. Conversely, When the Federal Reserve Board announced a possibility of easing back on the stimulus and bonds tanked, these were the same people pulling their money out. This is a clear, ugly and leveraged speculative rotation.
The markets themselves tell a different story. The Fed can’t afford to let off the stimulus gas just yet and the major market players know it. They also see the sucker top forming in the equity markets. The appropriate strategy we see is to tighten up equity risk and look towards the long end of the yield curve to regain some of its losses. Frankly, we think moving from equities to bonds should be the primary move between now and October. Take advantage of the access to information we now have and know that ignorance is a choice.