Happy Days Are Here Again

By John Lumbard

.  The economy is strengthening. Home prices have jumped 10% in the last twelve months alone, and home equity—the part of the home that the homeowner actually owns, is up an incredible 25%.  Over the same period the stock market is up 20%, adding another $2.5 trillion to the suddenly-bulging pockets of the average man in the street.

It’s about time.  The official start of the last recession was December of 2007 (in a newsletter the next month we declared the start of a recession); and while it ended in June of 2009, consumers continued to reduce their debt until the final months of 2012.  The federal government took up the slack, borrowing and spending in their stead;  this softened the pain of 2009 and 2010, but there was a heavy price to pay in the following years—above and beyond the burden of trillions of dollars in additional debt.

It’s called fiscal drag.  Let’s say the nation of Fluoristan borrows a trillion dollars and spends it.  The GDP of Fluoristan for that year rises by (almost) a trillion dollars, causing the people of that great nation to feel rich and happy.  The following year, however, the absence of that trillion dollars in spending would mean that GDP would be a trillion dollars lower.  Sadness would roll across the land.

The only way to avoid that bitter decline in GDP is to borrow another trillion, and do the same again the following year.  That’s what Japan did, year after year, for 23 years . . . The really wonderful news of 2013 is that we’ve changed course.  Two years of bloodshed in the halls of Congress have cut the federal deficit in half—in half!—and yet our economy has been able to shrug off the spending cuts and tax increases and grow.

In the first months of 2013 we’ve had to overcome the fiscal drag of a big increase in the FICA payroll tax, barely mentioned by the media, that’s taking $115 billion out of the pockets of the 99%—while a new round of tax increases on the 1% takes $62 billion.  The sequester cut government spending by $85 billion.  These changes are permanent, but they’ll only depress the growth of GDP this year.  Growth will resume from a lower level of GDP, and the pace will quicken a bit because government spending is inferior to investment and consumer spending.

In the second half of 2013 our economic engines will be unleashed.  Investors are snapping up homes, land, and commercial properties.  Auto sales are strong, oil and gas production is booming, and manufacturers from all over the world are building plants in the U.S. to take advantage of our cheap natural gas, plentiful labor, and access to consumers and markets.

With interest rates this low stocks should be twice as high as they are today, and they’ll still look cheap even when interest rates have doubled.  Corporate earnings are growing nicely—on page 3 Paul Wright explains why—and most of the monsters (European bankruptcies, our own deficit, the sequester, tax increases, Quantitative Easing) have been shooed out from under the bed.

Wall Street is suddenly brimming with confidence, and that makes us feel . . . uneasy.  When the stock market is rising it “climbs a wall of worry”;  when you feel like you’re riding an elevator to the top, you should worry that you’re nearing a top.  And this is a time of year when interim tops are common.

The Stock Trader’s Almanac says that $10,000 invested in the Dow since 1950—but only in the market from November through April—would have been worth $684,073 at the end of 2011.  The same $10,000 invested from May to October for 61 years would have lost $1,024.  The seasonal pattern exists in stock markets all over the world, and in the US in recent years it’s become worse, not better!

Yes, we think that’s crazy too.  We did trim our oversized equity positions in recent weeks, hoping to reinvest at lower prices in the dog days of September, but we’re taking some money temporarily out of stocks, rather than setting cash aside because it’s safe.  There’s nothing safe about a near-zero return if you’re living on the income from your investments.

Bonds will eventually lose more money for investors than they lost in the financial crisis.  Gold?  The party is over.  High unemployment rates are keeping inflation low, and the U.S. energy boom is driving up the value of the dollar.  Stocks are the place to be, and we hope to be fully invested again before the first blaze of autumn rises from the valley bottoms.

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