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Longboat Key Wednesday, Aug. 27, 2014 5 years ago

Market Watch

by: George Rauch

We are in the greatest bull market in history. Banks are loaded with cash. Corporate profit margins are setting records. Prosperity in America is abundant. The employment situation is improving, although wages are suppressed.Corporate cash buildup is the greatest in history. Dividend payout to stockholders is one-third of earnings per share, down from 52% historically, which means further dividend increases are likely. This has been an incredible 50-year run.

What is the normal economic reaction to having so much cash in the economy?
Record amounts of cash exist because investors have no alternatives for the cash. That forces interest rates down. Because the banks are holding so much cash, credit becomes easier because interest rates are low. Investment in buildings and machinery is likely to increase.

What kind of environment is required for the market to go up from these record levels?
This is an ideal environment for continued market success because of how the stock market works. When expectations for economic success are high, investors become optimistic, and they are willing to pay more for earnings. That inflates the stock market by increasing price earnings ratios. If optimistic investors see continued increases in corporate earnings, they are likely to pay more for earnings than they would in an average market, hence, the increasing price-earnings ratios.

With everything so rosy, isn’t it likely the market will continue to go up?
Investors feel the market is currently priced fairly. There remains a lot of pressure on earnings from projected tax increases and wages, which have not had a good hike in several years. On government spending and taxes, investors know that either taxes will go up or the deficit will continue to increase, each of which is bad for the economy. There will continue to be increases in dividend payouts.

Employees expect more income to make up for inflation losses suffered in the last several years. Those are a natural part of the business cycle, and they generally gain a head of steam when the economy is loaded with cash. Everybody wants their share. These factors compete with both corporate earnings and cash available in the marketplace.

Is it possible a good deal of that cash could find its way into the stock market, thereby increasing these already high values?
It is possible. The price of stocks is subject to the law of supply and demand, like everything else in the market. A lot of available cash is going to be invested. That puts upward pressure on a limited amount of available stock, which causes prices to increase. Because U.S. markets are so liquid and so efficient, U.S. markets are a very easy place for investors to place their money. Currently, 17.5% of the world’s population is involved in war. Money flees from those countries and seeks safety. The U.S. market is the safest. These facts might cause U.S. markets to continue increasing in value.

Is there no end in sight of prosperity?
There is an end in sight. The date, however, is not predictable. These 50 years of prosperity have been built upon the greatest mountain of debt ever created.

Since 1964, everything has been leveraged to the hilt. Nothing backs the dollar but debt, so the dollar cannot be redeemed for anything but debt. The Federal Reserve is in charge of our money, which means it is in charge of our government, yet we cannot audit its books, as the IRS requires in corporate and individual audits. Nor can we take a physical inventory of our gold. When government, or arms of government, deny these things, it’s always bad news, and when the digging is over, the harm finally comes to light. When you combine tremendous increases in debt with the inability of members of the public to see what they allegedly own, you know there is a problem.

Until the bubble bursts, we are going to enjoy prosperity. Will it be another 50 years? Of course it will, if we have continued confidence in the dollar and our government. But not if that confidence wanes substantially.

Further investment in the market is a coin toss. Nobody knows what will happen, and when the market is already highly priced, it bears an amount of risk that exceeds most investors’ appetites. Wise investors are sitting on cash and investing judiciously.

The American Institute for Economic Research (AIER) Business Cycle Conditions indicators all point to an outlook for the economy that remains favorable. Its Diffusion Index of Leaders suggests a low probability of recession in upcoming quarters. The outlook for continued economic success is good in the intermediate term.

Caveat Emptor.

George Rauch, Longboat Key, is chief executive officer of Bradenton-based General Propeller and a former Wall Street investment banker.


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