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Longboat Key Wednesday, Sep. 2, 2009 8 years ago

If not for debt, 'bull' would be back

by: George Rauch

Let’s start with a technical analysis of the stock market:

It is hovering around 9,500 points, 4,700 points below its high of 14,165 in October 2007. The market hit 6,542 on March 9, which, so far, has signaled the low for the bear market.

The first important positive technical hurdle occurred Aug. 7, when the Dow Jones Industrial Average and the Dow Jones Transportation Average simultaneously reached new highs in the current market upswing.

Dow Theory is explicit in that “no significant movement up or down in the market may occur without the Transportation Average confirming new highs or lows in the Dow Industrial Average.”

The next big step in this market would be witnessing the Dow Industrials reaching 10,354 points, 850 points higher than current levels. If the Industrials reach 10,354, the halfway mark between the high of 14,165 points and the March low of 6,542, a huge technical milestone would be reached. If the Dow Transports confirm the resurgent Dow Industrials after they have reached 10,354 points, there is a good bet that the bear market is over, and we really are in a new bull market.

But a brand-new, full-blown bull market will certainly encounter many and extreme difficulties. 
Problems in the economy

At this point, U.S. private savings is now confirmed to be at least 7% and thought to be 9%. That is huge, and it has accounted for trillions of dollars in savings being accumulated over the last few years.

To improve the economy, there must be an increase in consumer demand that will entice savers to part with some of their savings and spend their money.

The whole idea of a stimulus program is to encourage the public at large to spend their money. Prudent business operators and families, however, are not spending on anything but necessities. The fear of further economic collapse encourages people to build savings and discourages people from spending those savings. An increase in demand cannot be created by government, or Federal Reserve System, policy.

Unemployment now exceeds 10% and is approaching 12%. The Bureau of Labor Statistics estimates that we will lose 8 million jobs in this economic downturn. Additionally, we need to develop 150,000 jobs a month in this country just to absorb labor entering the employment market.

For us to be whole again, we need to return the 8 million jobs plus 150,000 jobs a month, which will be tough and take time, particularly if people choose to continue to save rather than spend part of their savings.

Not included in these figures are 6 million people who are working part-time and are looking for full-time jobs. These statistics dampen the probability for rapid economic expansion. To get back to where we were in jobs a year ago, 23 million jobs need to be created in five years. That would mean adding 15% annually to the employment base. Unlikely!

The housing market, a significant part of our economy, has been picking up. In the month of July, of the houses that were sold, about 30% of them were short sales from banks (that lost money on each sale), and another 30% of homes sold were foreclosures. So 60% of houses sold recently are houses that are moving because they are troubled assets. When this inventory is depleted and newly built houses are being absorbed by demand, the housing market will be on the way to being whole again. But it is certainly not well yet.

Estimates of the government’s bailout funds range all the way up to $12.9 trillion, and nobody can check the sources of these estimates because the Federal Reserve System has never been audited. There is an attempt in Congress to have the Fed audited so that we can measure the real obligations of our financial system. The resistance to auditing the Fed is so great one can only surmise that there are things in that audit the public cannot see, because it would make them furious if they did. Continued government dishonesty and lack of disclosure will not help in rebuilding any kind of economic resurgence.

Seventy-seven banks have closed so far this year. Many other banks are insolvent. Nobody in the private sector really knows the magnitude of the problems with these other banks, which is another reason for auditing the Fed.

The new rule, to mark to the market, assets held by lending institutions is creating a furor among bankers.

They know that marking most of their troubled assets to current value means marking them down substantially from where they are currently carried on the books. That means banks would report large losses of capital. Further, many other banks would be insolvent. Until we get beyond bank foreclosures, which may last another 18 to 24 months, economic recovery will remain frustrated. 

In the 1960s, Hamilton Bolton, one of the founders of Bank Credit Analyst, and also a strong Dow Theory proponent, proved that every $3 of new debt produced $1 of new GDP. Mr. Bolton’s successor, Ian McAvit, writes in his latest report, “Over the four years to September 2007 when the meltdown began, U.S. GDP rose $2.86 trillion, or 25.8%. Total credit market debt increased by $14.85 trillion over those four years.

This translated into $5.19 of new debt for every $1 of new GDP (14.85 ÷ 2.86 = 5.19). In the two years to September 2008, new debt required for each $1 of additional GPD had ballooned to $6.49. Increasing federal debt to recapitalize banks isn’t going to translate into resurgent growth and consumer spending.”

Remember, each new dollar of debt, and we have at least $3 trillion this year, requires interest payments.

Those interest payments take away from money that could be spent on something that is more productive in creating jobs.

Here are some interesting numbers through July 31 that relate to our economy in this fiscal year:

· Federal deficit for July: $181 billion (a record)

· Total deficit so far in 2009: $1.3 trillion (a record)

· Government spending in July: $332 billion (a record)

· U.S. government receipts in July: $152 billion (5.6% decline from ’08) 

Any reasonable human being who understands math can see these numbers cannot be sustained.

Furthermore, there is no indication in government planning, or in economic activity, that this disastrous posture created by our government will be abated at all, let alone any time soon!

To compound the problem, government revenues are down 33% this year, and government transfer payments (stimulus funds) are up 33% this year. These are not good, or healthy, signs.

In 1984, total U.S. debt was 1.25 times greater than GDP. In 2009, our total debt is 3.1 times greater than GDP. We are swimming in a tidal wave of debt. 

We have run into the problem of trying to find buyers for the national debt. Seventy percent of our past national debt is owned by Social Security and Medicare, the former which is using 100% of its annual donations, and the latter which is already running deeply in the red. That eliminates them as further buyers of treasury funds.

The two recent biggest buyers of U.S. treasury securities, China and Japan, are not buying any more treasuries because, with the value of the dollar going down, they lose money daily. The only thing left is a scam: The Fed creates the money with a printing press and turns around and uses that new money to purchase debt from the Treasury Department, and debt results from deficit spending. Because nothing of value was rendered for the new cash, there is now much more cash in the economy than is necessary for the goods and services that can be made available in the economy. The result is inflation.

We may stave off inflation a little bit while unemployment remains high; however, we will get slammed in the future if and when full employment returns.

The current decrease in the value of the dollar is a direct result of investor fears of future inflation. Walter Wriston, long-time chairman of Citibank, which was successful in the ’60s and ’70s, says, “Money goes where it is wanted and stays where it is well treated.” We may expect the irresponsible treatment of our money supply to chase investors away until the government takes some reasonable action to balance the budget.

Suffice it to say, the outlook is gloomy. We are not in a confirmed bull market, even though many economists say we are. We are not healthy, even though many economists say we are recovering.

What to do?
There is nothing wrong with cash. It gives you time to think. There is a huge socialistic agenda being placed before the Congress. All of these agendas are to be paid from “increasing tax revenues.” That is government speak for “tax the rich” because there is no one else to tax. Margaret Thatcher said, “The problem with socialism is that eventually you run out of other people’s money!”

For investors interested in equities, there are some buys. All of the following are A-rated companies with long-term records of both increasing dividends and increasing earnings. They all yield 3.4% or more, and they all sell at price-earnings ratios far under their historical averages: Abbott Labs, Altria, Chevron, Clorox, Coca-Cola, Emerson, Home Depot, Johnson & Johnson, McDonald’s, Pepsico, Phillip Morris International Inc., Proctor & Gamble and Sysco. We have not seen a list of good values in so many A-rated companies in more than quarter of a century.

There is a bright spot. U.S. factory utilization is the lowest it has been since World War II. Our factories are in good shape. When business improves, the private sector will be gushing cash. If the profits are not stolen by the government and business is allowed to hire more people and produce more products, our economy could be cured more quickly than it appears. 

Caveat Emptor.

George Rauch is a Longboat Key resident and owner of Bradenton-based General Propeller.

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