The S&P500 and the Value of American Business

I’m writing this on March 20. By the time this shows up on my blog things might have changed drastically but I am guessing not. 

The topic never goes away. Many of us have money in the US stock market. Some of us buy individual stocks and we watch how Amazon or Microsoft stock prices change from time to time. Others have mutual funds that allow them to own a whole portfolio of stocks. We don’t much care if one stock goes down so long as the value of all the stocks rises. We track how our mutual funds are doing. The Dow Jones and S&P 500 averages tell us how a large groups of stocks are doing.

The market closed down on Friday, March 20, with the S&P value at 2304. That means that after rising to as high as 3400 earlier this year, the S&P value is now down to about what it was in 2017. Mathematically, we could say the S&P 500 has given us zero growth over the past three years. We could say the S&P 500 is now roughly 1100 points lower than it was a month ago – a net loss of about 32%. In 2010, the value was about 1200. You could say that in the past 10 years the S&P 500 almost doubled – even at the low value of 2300 today.

What do we make of all this? Some people tell us that indices like the S&P and DJ tell us the value of corporate America. Does the value of all those buildings and computers and software and equipment jump around like the stock market? Probably not. 

Someone might say that it is not really the fundamental values of all that stuff but more so the expected future values of the profits all that stuff might generate. This seems to make more sense. If the future looks scary for firms, then maybe their profits will fall and people will not value the stocks as much. When we are highly optimistic about the future, then we buy stocks and are willing to pay higher prices because we think we will share in the good results that come.

Since expectations about the future can be pretty fluid, stock markets can jump around a lot despite the fact that the value of the underlying assets of the companies has not changed very much.

Where does that put us? For one thing, it helps to not panic. Expectations presently are wildly pessimistic about business and the future of profits. If you believe it is better to sell stocks when their prices are high, then you probably do not want to sell stocks at these very low values. Of course, you might not have a choice. Maybe you need to sell stocks to pay for your kid’s education or to finally get that Beamer you always wanted. 

But notice there are always choices. Maybe it would be better to sell your antique doll collection than to sell your stocks. Maybe this is a good time to borrow to make your purchases. Maybe grandpa will give you a loan. Selling stock right now is not a great idea.

The big question is how long it will take before future expectations and stocks return to more normal values. If the time is short, there are lots of ways to avoid selling stocks. But if it takes 5 or 10 years, then maybe our options are more limited. Especially for you older folks – will you be alive when the market becomes more normal again?

Sadly, we don’t know the timing. The health/economic challenges we face now are new to us. But I can say that the stock markets, like your weight measured daily, can rise and fall, and most of us should just look away from all that noise. It will drive you crazy but it really has almost nothing to do with you. The stock market values each day during such a pessimistic time are bound to be disconcerting. But they are not telling you what American business is worth, and they tell you very little about what they will be worth in the future.

One caveat. We cannot be sure how the political responses to the coming recession and Covid will permanently impact impact government control and regulation over companies. It is easy to see why that could negatively impact productivity and the value of capital. 

Hang in there for now, and don’t do anything crazy.

The Fed is Not Incompetent. It is Corrupt.

Like a dog with a bone, I refuse to release it. The bone is monetary policy. And the more I read about Fed policy the more I want to yank that bone out of  my master’s evil hand.

Many of you know me. You know I don’t jump from the frying pan into the fire. Or vice versa. I don’t jump on conspiracy theories. I am boringly middle of the road. 

But just in the last weeks it hit me like a ton of bricks. The Fed is not incompetent. I usually refer to the Fed as a bunch of bozos. But I take that back. I cannot escape the conclusion of late that they know exactly what they are doing and what they are doing is corrupt. In the name of saving the economy and our jobs – what they are really doing is saving the asses of powerful people in the financial markets. They don’t give one hoot about all those retirees and potential future retirees who will now receive zero interest on their lifetime accumulations. 

What they care about are wealthy people and institutions who take too much risk in financial markets. These game players are being bailed out by the Fed despite the fact that the Fed knows that monetary policy actions taken today or tomorrow will have zero impact on the economy. To hell with the economy. To hell with the stock market. Too hell with retirees. Instead, save all those fools who participate in the riskiest markets for basically their own financial gain. That’s who the Fed is helping today. It is sad things have gotten that bad.

The interesting thing about monetary policy is that it is a lot like Dolly Parton’s undergarments. They are pretty much a mystery. In any econ department just about anywhere there is some guy or gal teaching monetary policy. This guy or gal is usually not very popular. Why? Because monetary policy is inscrutable. I remember Clarence Philbrook taught monetary policy at UNC when my cohort was going through there. 

Sure, econometrics was tough but Peter Schmidt was a great teacher. Dick Froyen made macroeconomics understandable. Bill Pfouts taught a non-mathematical microeconomics course that made a lot of sense. But poor Clarence. No one understood a word he said. Jesse L to this day swears he never learned one thing in that course.

Monetary economics sadly suffers from being interesting – it always brings together theory, history, and ideology. But it suffers because no one really understands what money is and why it is important in a modern economy. And then there is this thing called a central bank that somehow is given the legal and moral right to print as much money as they want. Don’t worry folks, these people at the Fed love you and they would never abuse this precious responsibility. Right? If you said said yes, then I have a bridge I’d like to sell you.

Enough background. Get to the point Larry.

Recent history. The Fed pumped enough money into the US economy in the last years to fill the grand canyon and Green Lake. That means that banks are awash with money. There is so much of it that they couldn’t possibly lend it out.*  It ended up in a category that only Clarence Philbrook understood – called excess reserves. Excess reserves make about as much sense as you and I having “too much money”. Tuna, you have too much money. I know Larry. It’s fun. I put it in a wheel barrow and move it around town so everyone will see I have money I don’t need. 

Excess Reserves is money that banks don’t lend. It just sits around doing nothing for no one. In the good old days the Fed would remove it. Made sense. Add too much. Remove it. Rocket science. But our Fed today didn’t remove it.

Point – if commercial banks need money for something today – it is there. And lots of it. But it doesn’t even matter. The Fed just dumped another giant load of money on the economy. Wasn't there already enough money? Why did they dump even more?

Answer – there is no answer. What did they say? Did they say that borrowers were being turned away from banks? No. They didn’t say that. Did they say that car-buyers could not find loans or that home buyers could not find mortgages? No. They did not say that.

They said that markets were not functioning properly and that mortgage and other bonds interest rates were rising. Aha. Now they actually said something. But you know what? Most people have no idea what that means. I am not even sure I know what that means. I have been studying money since Spanky and our Gang was the top show on TV.

Here’s my guess. A bunch of financial players had a bunch of bonds sitting there and decided that the prices on those bonds were going to fall. As you know, when it comes to recessions, lots of asset prices decline. So instead of taking care of their own stuff – they get some of their powerful buddies to call the Fed – and say something like – Hey Fed you are killing us rich folks. We have worthless bonds. Buy them from us.

Thus Jay and the boys and girls at the Fed quit sucking their thumbs over the virus and bought a bunch of worthless bonds from a bunch of influential people who thought they were going to lose some money. Instead of hedging or covering their collective asses in the usual ways of markets, they decided it was better to have the corrupt Fed take care of them. The disquiet in the bond markets subsided and the world was once again safe to watch reruns of Lassie and Howdy Doody.

Well maybe not. People wonder why the Fed can't do anything right these days. Maybe the reason is that people know the Fed is corrupt and is simply going to make one mistake after the next. Maybe that is what has changed. We all know the Emperor is wearing no clothes. 

* I checked the data. Before 2008 banks held less than $2 billion in excess reserves. Then the Fed went crazy. By 2014 banks were holding an average of $2.7 trillion in excess reserves. From $2 billion to almost $3 trillion! Wow! By March 20th of this year the average amount declined to $1.6 trillion. Yes trillion. There is still a ton of money out there. Why add more? Liquidity crisis? You gotta be kidding me. 

The Lender of First Resort

Macroeconomists called Keynesians advocate using monetary and fiscal policy to correct weaknesses in the economy. That is standard macro. 

But their Lord and master, John Maynard Keynes, made very clear that there were times when monetary policy would be essentially useless. He called it “pushing on a string”. Standard macro courses cover a topic called the liquidity trap. 

A country will fall into a liquidity trap when investors are so uncertain about the future that they seek only money. They don’t trust bonds and stocks and just want to hold money (or gold).

During a liquidity trap, the Fed can pump enough money to fill the Columbia River, but since there is such a high demand for it, the money gets held and is not spent. Like pushing on a string, you get no impact. Just money sitting around in banks.  

Despite this standard theory and an amazingly good fit for the liquidity trap today, the Fed is whistling Dixie as it pretends to save the day with yet another boatload of money.

Hey Sweetie, I lost my job at the tomato factory in Leamington. That’s okay, Honey, the Fed is going to lower the interest rate.

Hey Sweetie, we can’t make our mortgage payment this month. That’s okay, Honey, the Fed is going to lower the interest rate.

Hey Sweetie, I just ran out of gas on Highway 5. That’s okay, Honey, the Fed is going to lower the interest rate.

Hey Sweetie, my Viagra isn’t working. That’s okay, Honey, the Fed is going to lower the interest rate.

Hey Sweetie, we have way too much debt now. That’s okay, Honey, the Fed is going to lower the interest rate.

Hey Sweetie, little Johnny got caught stealing cigarettes at the Piggly Wiggly. That's okay, Honey, the Fed is going to lower the interest rate.

Hey Sweetie, I think the economy is going to fall apart. That’s okay, Honey, the Fed is going to lower the interest rate.

Hey Sweetie, it's much too cloudy and cold here in Seattle. That’s okay, Honey, the Fed is going to lower the interest rate.

You might ask, what does the Fed and the interest rate have to do with all our problems?

Answer: very little. Worse yet, when the Fed decides to save the day, does that make us more or less optimistic? How does that affect the economy?

After market forces pushed some interest rates below 1% recently, did we really need the Fed to try to push it even lower? 

How do all those folks living on the returns on their bonds feel about the Fed lowering the interest rate closer to zero?

Will that little additional change in interest rates really solve the globe’s economic problems after the onset of a medical alert?

The Fed is the lender of last resort. When all else fails, then maybe we need the Fed to step in. But have we really tried to attack our current problems with sensible solutions? 

Is this using the Fed as the first resort?

Is this admitting that when we panic and don’t have any real solutions, we don’t mind throwing the baby out with the bath water?

I think I am out of questions. 

By the way, Keynes advocated using fiscal policies for times like these. But sadly we have gotten our country into such a debt mess that we have no more dry ammo. 

Liquidity trap, no ammo, and a sinking economy. Our leaders need to find a different job. They really suck. Yes, they did this to us for their own personal greed and corruption. 

Income Inequality by Guest Blogger Anonymous*

I’m concerned about the various condemnations of income inequality.  It is being treated by many philosophers, ideologues and even economists as inherently wrong. 

Income, and it’s evil cousin net worth, often reflect the amount society pays for labor and other artifacts of productivity according to the value realized.  I don’t think LeBron is worth $75M/year but I can’t shoot 3 point shots or dunk.   

Some people object to doctors pulling down $500K, even though the average debt at med school graduation runs around $200K and many peg it closer to $300K.  12 years of college, med school, internship and residency (more for surgeons and anyone who signs on for a fellowship), also carries a time cost.  Their malpractice insurance premiums are much higher than those of public school teachers and sales reps.  Seeing your first paying customer at 34 is a pronounced handicap.  My point here is that some jobs pay more because few people are qualified and also because they’re worth a lot.  

The real issue is that many people simply choose not to make the sacrifices required to earn huge amounts of money.  Independent of skills and aptitude, lots of people are content to work 40 hours, earn a respectable living and have nights and weekends free to do as they please.  Risking one’s entire nest egg to start an online book selling business that competes with Borders and Barnes & Noble is not everybody’s cup of tea.  Some people forego all-consuming jobs so they can care for a parent or child, enjoy a little travel/leisure or they simply want to tend their garden.  Maybe $40K is enough (maybe not in Manhattan).  Economics is the study of choices, and their consequences.  

When people choose to balance income and lifestyle, maybe that’s okay.  The price of food relative to household income is low (1).  The price of gas, compared to its 20 year average, is low (2).  Borrowing costs are low.  Household debt has been trending steeply downward for the last 10 years (3). Disparities that result in poor nutrition, inadequate medical care, lack of basic needs or wage discrimination for any reason are another issue and are not okay.  

Perhaps some consideration should be given to the large number of people who make less than Warren Buffet and don’t care, or at least don’t care enough to learn how to shoot 40% from beyond the arc or perform pediatric neurosurgery.  In the end, deprivation needs to be teased away from envy.   

Inequality does not always imply injustice.

*Anonymous is a long-term resident of Bloomington, Indiana.

2. https://www.google.com/amp/s/amp.usatoday.com/amp/2710634001

1. https://www.valuepenguin.com/how-much-we-spend-food

3. https://tradingeconomics.com/united-states/households-debt-to-gdp

Anticipation

Remember the Carly Simon song "Anticipation"? The lyrics — "Anticipation, Anticipation, is making me late. Is keeping me waiting" — seem to say a lot about the coronavirus.

Everyone else is weighing in on the coronavirus, why shouldn’t I?

My focus today is the economy, and some hurdles we have to pass. I think I have two points that have not been sufficiently appreciated.

But first, what do we know? Or better said, what do we not know?

We don’t know how much the virus is going to spread and for how long. If we knew that the virus has already peaked and that the spread of it is going to diminish, then that might affect our economic behaviors. But we don’t know that. So anything is possible and gloom and doom are within the scope of “anything.” Inasmuch, anticipation is everything. Clearly, anticipation means all sorts of economic transactions are on hold. 

But let’s hold that thought a minute and focus on a couple of other things that have not been emphasized.

First is the unfolding of economic news. Economic activity has clearly been affected by the virus. While the demand for face masks has risen dramatically, that cannot possibly overturn all the declines in spending and production that have already occurred due to quarantines and uncertainty’s impact on activity. One of the world’s largest countries, China, has been on a basic shutdown and that has had impacts on the the global supply chains for everything from tires to toys.

We read about all that, but the truth is, reporting of national data takes time. Statistics like personal income and industrial production come out monthly. The major summaries of activity, including the GDP numbers, are published quarterly. As a result, we won’t actually see the data measuring the declines in economic activity for a couple of months and only then will we see more vividly and completely how the virus has impacted economic activity. That information will be hitting us like the mosquitos in summer and maybe even through the fall.

Second is the reactions of those folks who are hoping to run against Trump on the Democratic ticket. When Obama was in office, it was clear that many politicians used that recession to criticize capitalism. It was not just that the economy was in a recession, but that the recession seemed to be the proof that capitalism had become a relic – worse, it had become a detriment to us all. We could not trust business, we had to trust government. 

We are getting very close to another major election and the economic rug has been pulled out from under President Trump. He will not be able to brag about the economy. Whether or not Bernie Sanders is a socialist is not paramount. Liberal progressives can use this weak economy as another example of the failures of business. Okay – this downturn might be a fluke, but there’s no reason to stop there. Could this recession fuel a long-burning desire to add even more layers of government regulation on business and even more taxes on the rich?

Aside from the actual evolution of the virus, these two factors could have significant long-run impacts on the economy. And like the virus itself, we can ponder these two points but we cannot easily make guesses about how important they will be.

Will the actual economic data announced in the next three to six months be worse than what we now expect? If so, will that realization create even more uncertainty and negative impacts on growth?

Will the Bern or others running for office take this opportunity to put the last stake into the heart of capitalism? Will that not impact economic growth for a long time to come?

Or maybe not. Maybe the data will not be taken as negative. Maybe Bernie and his friends will not want to dismantle capitalism in the near future.

Exciting times we live in. Eh?