A big day on Wall Street yesterday.
The Dow was up more than 500 points after Federal Reserve chairman Jerome Powell told investors they have nothing to fear. FXNews is on the case:
Here are the highlights from this morning’s ‘Conference On Monetary Strategy, Tools, And Communications Practices’ in Chicago:
‘We [FED] are closely monitoring the implications of recent developments [tariffs] on the US economic outlook.
‘We [FED] will act as appropriate to sustain the expansion.
‘FED policy remains data dependent.
‘Persistently low inflation could lead to downward drift in expectations.’
Yes, the great wizards at Fed headquarters will heal every wound, soothe every heart, and make sure there is no pot without a chicken in it.
‘Don’t fight the Fed’ is one of the most sacred dicta on Wall Street. And usually one of the most profitable. So, if the Fed is pushing up stock prices, how could a stock buyer possibly go wrong?
Herewith, we wonder…how does Fed policy really connect to the real world of time, money, work, profits, innovation, forbearance, and all the other things that produce real wealth?
Last week, we pointed to the good example of King Cnut. The medieval king stepped into the North Sea and commanded the tide; it paid no attention. ‘You see,’ he said to his knights, ‘even the most powerful of men cannot stop the cycles of the natural world’ (or words to that effect).
Governments can pass laws. They can force people to pay taxes. They can even tell the sun to rise in the morning, but not in the evening.
But if the feds were to tell everyone that henceforth, they should go about with pumpkins on their heads, full compliance may be difficult.
Likewise, the Fed can influence prices and alter the natural rhythm of the market, but only up to a point. If it had full control, all the time, we wouldn’t have recessions, bear markets, crashes, hyperinflation, or anything else we don’t want.
If the feds really could command an economy, the people of Venezuela wouldn’t be starving, for example. And Argentina wouldn’t have 40% (or 100%…if you believe some sources) inflation. And the poor American working stiff would have gotten a substantial raise some time in the last 45 years.
The ‘data dependent’ schtick is just another example of jackassery. You may use incoming data (light) to tell you when the sun is rising. But that doesn’t mean you can tell the sun to set before it is good and ready. Nature doesn’t like to be disrespected.
Nor is disrespecting Mr Market a good idea. He puts up with a lot. But only so much. So, the real question is: How far can the feds go before Mr Market gets fed up?
Mr Powell says he will ‘sustain the expansion.’ ‘Oh yeah?’ says Mr Market.
In the downturn of 2000, the Greenspan Fed cut the federal funds rate by 500 basis points. Still, in terms of gold, the Dow fell 82%. In 2008/2009, the Bernanke Fed again cut rates by 500 basis points. Once again, stocks nevertheless lost 68%.
And now, the expansion seems to be approaching its end (it has to end sometime!)…and the Fed only has 240 basis points to cut.
Besides, the Fed cannot really make companies more valuable. It can’t increase their sales; it can’t really increase their profits. It can’t improve their products or strengthen their marketing. It can’t create more time. Or more real money. Or make people smarter or more inventive.
All it can do is mislead you and misallocate resources with fake money and fake price signals.
We recently looked at one company to see how this works. A friend mocked our Dow-to-Gold allocation strategy, which keeps us out of stocks for long and agonising periods.
‘You’ve been at an orgy for the last 10 years and you’ve been sitting on your hands. You won’t get much satisfaction that way,’ he seemed to say.
He went on to explain that he had made good money by investing in one of the oldest, most reliable companies in the country — The Hershey Company.
The company provided real goods and services — at a profit, he pointed out. With a profit margin of about 15%, Hershey’s is a good business with a reliable stream of income.
But the gains didn’t come from selling chocolate. In 2010, the company sold $5.6 billion worth of chocolate. In 2018, it was up to $7.8 billion. A nice, 40% increase.
But the stock went from $27 to $133. That’s a 390% increase…almost 10 times as much. How come?
Generally, owning a profit-making business is the best way to make money. Because it’s part of the great win-win world — an investor deserves to be compensated for adding to the happiness and satisfaction (and probably the obesity and tooth decay, too!) of others. He deserves to participate in the earnings.
And Hershey investors did. The company paid an annual dividend of about 2.2% over the last 10 years — about the same as a 10-year T-bond.
But where did the rest of the gain come from? According to classic theory, an investor deserves the Treasury rate…plus a little more to compensate for the additional risk. But 350% more? How is that possible?
The answer, of course, is that it had nothing to do with the chocolate business or satisfying customers. Instead, investors were unwitting accomplices to an elaborate fraud…a major rip-off…and a Ponzi scheme.
This is the trend of ‘financialisation’ we have discussed in these pages. The win-win world of producing goods for consumers was upstaged by the win-lose world of financial wizardry and negative real interest rates.
And, according to our back-of-the-envelope calculations, the US now has about $50 trillion worth of this empty, Ponzi wealth — in pumped-up stocks, bonds, and real estate valuations. Mythical capital.
Ponzi or pyramid schemes work by taking in fresh capital and pretending it is earnings. The problem is, when word gets out, the new capital disappears. So does the old capital. The whole thing collapses.
Likewise, from 2009 to 2019, the stock market took in fake capital…and pretended it was real money.
Wall Street doctored ‘earnings,’ ballyhooed ‘better-than-expected’ results, saluted share buybacks, mergers, and acquisitions, and rewarded goofy pie-in-the-sky IPOs with billion-dollar valuations.
And in this world, even good companies with real profits — like Hershey — were lifted up on the tide of EZ money.
In this New Age of ultra-low rates, explained the experts, a 2% yield was pretty good. Especially, when you get a 390% capital gain, too.
But, like any Ponzi scheme, the ‘profits’ are easy-come, easy-go. Eventually, the tide turns. And neither King Cnut nor Chairman Powell can stop it.