It doesn’t matter who wins the presidential election in America, says Dan Denning. Given the spendthrift nature of the American consumer and the fragility of the dollar, the equity market is going to fall anyway.
Many American investors appear to be convinced that the US election actually matters to the US stockmarket. With the election of either George W Bush or John Kerry as President of the United States on 2 November, they say, the US stockmarket should finally have the green light to put politics behind it and get back to its real business – going up indefinitely. Markets hate uncertainty, they say. Investors want to know who is going to be leading America for the next four years, and they won’t invest until they do. However, come the day after the election, they’ll release their cash back into shares and the bull market will be back. This is a charmingly optimistic view, but unfortunately it is very probably completely wrong. US stock prices have gone nowhere so far this year. They’re no higher than they were six years ago. And UK-based investors would have lost money on US stocks during that period – because of the falling dollar.
The fact is that it doesn’t matter who gets to be president the month after next. Neither Kerry nor George W Bush can repeal the law of gravity; neither can they prevent the world’s most unbalanced economy from finally falling down.In their hearts, investors know this. That’s why they haven’t been buying stocks this year. Here’s five reasons why they shouldn’t start now.
1: A bear is a bear, until it’s a bull
Markets do not just go up and down willy-nilly. They flow in great tides – tugged by the moon of interest rates and the sun of popular psychology. Yes, there are back-eddies and freak storms. But when Jeremy Grantham studied the pattern of stockmarket tides, he found that they had remained nearly the same for the last 200 years. Adjusted for inflation, prices generally go up for a period of 15 to 20 years. And then they go down for pretty much the same amount of time. In America, stocks peaked in 1929 and mostly fell for the next 20 years. In 1949, they began a major bull market – rising until 1966 – a 17-year stretch. Then, they fell again, until 1982 – a period of 16 years. In 1982, another great bull market began – one that ended in 2000, again lasting an 18-year period. The movements are never smooth or clear. But the results are always the same: once a major trend begins, it keeps going until it reaches a major end. This suggests that stocks will be going down for the next 11 to 16 years, and you’d be a fool to fight that trend.
2: Monetary policy can’t help any more
For the last couple of years, interest rates in the US have been historically low, hovering near zero. Yet even now, supposedly well into a recovery, and with hints of inflation on the horizon, they aren’t exactly rising fast. Federal Reserve Chairman Alan Greenspan says he cares about inflation. Yet he has raised short-term interest rates a mere half of one per cent – hardly a “tight” monetary policy.
The current inflation rate in America (meaning the rate at which consumer prices are going up) is close to 3%. At that rate, the Fed is lending money at only half the rate the money itself is losing value. In effect, Mr. Greenspan has been giving money away for years – and still is.While the Greenspan Fed made borrowing irresistible, the Bush administration set new records for spending it. In the space of 18 months, a huge federal surplus – a relic of the Clinton years – turned into a huge federal deficit. The difference came to more than $700bn – sprinkled around the US economy like pixie dust. “You give me a trillion dollars and I’ll show you a good time too,” said Warren Buffett of the resulting boomlet. Never before has an economy receivedso much stimulation.
The Fed’s easy-money juice started to reflate American markets in late 2002. The big gains then kicked in in the spring rally of 2003 and carried over to early 2004, during which time the Nasdaq gained nearly 80%, the Dow tacked on 40%, and even the XAU – an index of hedged gold stocks – soared 70%, proving once again that if you put out enough booze, even Republicans can have a good time.
Unfortunately, it rather looks as though the power of low rates to boost stockmarket returns is waning fast: today the Dow is hovering at 10,163, slightly down from where it started the year, despite rates remaining low. So what next? The Fed is clearly willing to provide as much cheap credit as necessary – the long-term consequences can go to the devil. But the more people borrow, the harder it becomes for them to borrow more. American consumers must reach their breaking point sometime; sooner or later, the long-term consequences of increasing debt must catch up on them. Is it happening now? We don’t know, but if you are relying on loose monetary policy to boost markets post-election, you shouldn’t be. With low rates both ineffective at boosting asset prices now, and likely to go up in 2005, selling US stocks now might save you losses later.
3. The dollar still has to fall
One of the odd side effects of lethargic global stockmarkets this year has been the strength – or lack of weakness – in the dollar. It has long been expected that America’s trade and fiscal deficits would, along with rising interest rates, bring the dollar down. But so far, nothing of the sort has happened. The trade-weighted dollar is up, year-to-date, by about 3.5%. But this short-term performance is not really the point. The real question is: what happens next? Is the benign behaviour of the dollar something that can continue into next year? Does the fact that a dead tree didn’t fall last winter mean that it will never fall? The answer to that, I think, is a firm ‘no’. The US twin deficits, fiscal and current account – about half a trillion dollars each – constitute real threats to the dollar’s stability. They aren’t going away.
Let’s take the current account first. You would think that, given high levels of personal debt, slow growing real incomes (in July, personal incomes grew just 0.1%), rinsing interest rates and rising energy costs, the Americans would be starting to cut back. Far from it. The latest numbers from the US government show that, in July, personal spending grew 0.8%. It seems to me that it’s getting harder for Americans to save money. So they aren’t. They’ve pretty much given up any pretence of thrift; they’re just spending it faster and faster.
Who pays the bills? Each day, Americans spend approximately $2bn more than they have to spend. The gap – the current-account deficit – is filled by loans from foreigners – many of them, maybe most of them, with a standard of living far below that of Americans.
This generous, if bewildering, behaviour of diligent savers across the globe is what keeps the American consumer economy going. But how long can this last? With US stockmarkets locked in neutral, it’s becoming increasingly likely that America is going to have trouble attracting the billions of dollars worth of foreign capital it needs every single day to finance the deficit. Why put your cash in an asset that never makes you a decent return? If foreigners decide that there’s no reason to do so, the dollar will fall – and it could fall hard.
4: The budget deficit isn’t going away
The second famous deficit that is plaguing America is the fiscal deficit. On an annual basis, the fiscal deficit too is now running to nearly half a trillion dollars. And that also isn’t going to change. Seventy per cent of American federal spending is non-discretionary – it is tied to programmes s
uch as Social Security and Medicare, which cannot be easily changed. No matter which candidate wins in November, don’t expect any major reforms…or major cut-backs. George Bush has yet to veto a spending bill. And John Kerry has yet to meet one he didn’t like.
This leave military spending as the largest discretionary item in the budget to be cut. But with America engaged in a global war on terror, as well as in Iraq and in Afghanistan, don’t count on seeing any decreases in military spending. Quite the contrary. However, America’s military programmes – like its domestic ones – are financed by loans from foreigners. Could it be that the Chinese and Japanese will weary of paying the price for America’s guns as well as its butter? Maybe.
Remember as well that supplies of capital are not infinite. Currently, the US takes 80% of the entire world’s savings. As American budget deficits absorb more and more capital, pressure on interest rates, the dollar, and on US stocks mounts.
5: The oil price
It took billions of years to create the world’s ready oil. Yet it’s being used up in the space of a few generations.
Hedge funds may have made bets in the futures markets. But long-term, oil is still a scarce resource, and it’s getting scarcer. The price of oil may have pulled back a little this week, but that won’t last. Worse, rising energy costs are just now being passed through to the American consumer – all of which means more discretionary income spent on energy and less on new goods and services, hence lower earnings and stock prices.
The last word
Any one of these threats should on its own be reason enough to persuade investors to sell American stocks. Together, they shout a warning for all the world to hear: get out now, while you still can – sell!
Category: Economics