#58 – The Faith Based Rally Continues, by Jason Hartman

The stock market is continuing its rally from market lows early in 2009.  To many free market economists, the stock market is seen as a harbinger of sentiment concerning the future of economic growth.  This has created jubilation on the part of many journalists and investment advisors, based on the belief that current stock market returns are predicting a robust economic recovery.  However, deeper analysis of this rally shows that it is heavy on ‘hopes and dreams’ while unfortunately light on fundamentals.

Analysis of the relationship between the S&P 500 market price and the earnings per share or dividends per share shows a much different picture.  Over the last 15 years, the ratio of prices to dividends reached astronomical levels.  This indicated a shift of market sentiment away from the fundamentals that drove earnings and dividends toward speculation on future appreciation as the primary driver of value in the stock market.  This phenomenon is also evident in the cycles of expansion and contraction in the P/E ratio for the S&P 500 index.

The recent market turmoil has escalated P/E ratios to unseen levels that will require dramatic increases in earnings for the current price levels to be supported by fundamentals.  The ratio of prices to dividends are also still very high relative to the historical average, communicating that market sentiment is still firmly in the camp of valuing the market based on the anticipation of future value appreciation instead of the fundamentals that drive earnings and the dividends that are paid out of earnings.

All of these trends point toward a further perpetuation of value bubbles, market crashes, nominal recoveries that create more bubbles.  Furthermore, these market cycles are likely to increase in severity over shorter and shorter time horizons.  The reason for this is a near complete disconnect between market values and economic fundamentals.  As this fracture continues to widen, it will result in market values fluctuation wildly.

Another major factor in these anticipated fluctuations is the government exercising its monetary authority to finance deficits by expanding the money supply.  (also known as ‘monetizing the debt’)  It is likely that future nominal value contractions will be ‘eased’ by infusions of new money by the government.  This will result in nominal value fluctuations that look moderate, but real value going down precipitously because of the dollar’s progressive weakening, due to expansionary monetary policy.

http://www.CreatingWealthPodcast.com & http://www.JasonHartman.com

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#53 – Fiscally Fit Financial Quiz

Fiscally Fit: A check-up for your financial fitness

1. What happens to home values when the replacement costs increase?

   1. The go up like a rocket

   2. They go down because nobody can afford to build

   3. They are pulled toward the cost of new construction

   4. They don’t change . . . construction costs don’t matter

2. What is happening to the economy now that the debt bubble has burst?

   1. The recovery going to happening, because Ben Bernake said so

   2. The government attempting to re-inflate the debt bubble in order to stimulate short-term demand

   3. It’s just like the great depression, only worse

   4. The recovery has already started . . . the government reporting agencies are just suppressing the information

3. What is happening to real unemployment?

   1. It is going up, contrary the manipulated numbers that are published

   2. Can’t you read? . . . it’s going down because the stimulus package is working

   3. It’s already higher than during the great depression

   4. It’s going to be back below five percent in no time

4. What happens when government spending becomes a bigger portion of total GDP?

   1. It gets the economy back on its feet

   2. It erodes long-term growth by displacing private investment capital

   3. It make people more equal by re-distributing income

   4. It makes the environment better because of government regulation

Answers: 1) c, 2) b, 3) a, 4) b

Explanation of Answers:

What happens to home values when the replacement costs increase?

Over time, home prices naturally converge toward the cost of construction. The reason for this is twofold. First, new housing starts tend to boom when prices are high, creating an increase in supply that generates more competition and usually lowers market prices toward equilibrium. Second, when prices are depressed and market values dip below the cost of construction, new housing starts will drop off precipitously. As an extended period of time passes with no new homes being built it will slowly pull prices up toward equilibrium. Thus, in all cases the cost of construction plus land is the approximate equilibrium point to which home prices naturally converge.

What is happening to the economy now that the debt bubble has burst?

The impact of the debt bubble bursting was a dramatic contraction in the availability of credit. This meant that many people who were previously spending on credit are no longer able to continue spending. In this kind of economic environment, many people begin ‘deleveraging’ or actively reducing their debt burden. However, in this economic cycle the government is attempting to stimulate short term demand with credit based spending, ostensibly re-inflating the debt bubble. The way that they are doing this is with tax credits for new home buyers or rebates for people that trade in old cards to purchase new ones. These programs are all encouraging increased indebtedness in an attempt to stimulate the economy. Unfortunately, sustained economic growth can only come from increases in production and productivity, and none of the government programs is addressing either fundamental factor of economic growth.

What is happening to real unemployment?

The way that government statistics track unemployment is to remove ‘discouraged workers’ from the pool by only tracking people that are actively seeking work. Fundamentally, this means that people who stop looking for work (and are not employed) are removed from the pool for counting the statistics. This means that the total number of jobless people can actually go up, while the unemployment rate goes down like what happened in July’09. Furthermore, the official numbers count people who are under-employed in part time work but would like to work full time as fully employed. It also counts people who work in commissioned sales like Real Estate or Insurance as being employed, even though they may not have earned a commission check for quite some time. When analyzing the strength of the economy, it is important to not only look at the published statistics, but the underlying assumptions.

What happens when government spending becomes a bigger portion of total GDP?

The important to thing to consider when talking about government spending is that the government cannot spend a single dime without taking it away from somebody else first. This comes from direct taxation, borrowing in the credit markets (displacing private capital), and printing money (devaluing the savings and equity of all people who hold dollar-denominated assets). As the government grows larger, it must necessarily displace or destroy private investment and spending to finance its operations. Since government operations are necessarily politically motivated, it naturally follows that the real output of government spending will result in substantially less production and productivity improvement than if that same capital had been deployed though private channels. As the government seizes control over more and more of the economy, it pushes more decisions onto the desk of politicians and neutralizes the market forces that create economic growth.

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