21 September 2017
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David Park
CEO of Austin Capital Trust
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Has the economy divorced itself from the market?
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Sometimes the stock market and the economy go in the same direction but sometimes not. But they are tied together so it can never get too far apart. Since WWII, this relationship has been very consistent. As you try to make sense of the market keep in mind that the market set records five days in a row in March even though unemployment remains high, corporate earnings are flat lining, and government spending is declining. Many have asked me about the affects of Government sequestration and the reason why there is a level of partisanship that seems unprecedented.  Simply put the budget clashes in Washington aren’t political theatre, they’re fighting over a shrinking pie. We have a smaller budget relative to our ambitious social and military desires. 

The question is whether the market is a self fulfilling prophecy and the wealth effect of the stock market and real estate boom will inspire confidence and pull the real economy higher. Or will the sluggish economy drag Wall Street down to reality? Profits have been buoyed by foreign growth and by the suppressed domestic wages. According to Sentier Research the income of the median U.S. household after inflation was 4.5 percent lower in January 2013 than in June 2009, the month the supposed recovery technically began. The U.S. economy is 5.8 percent below potential and the unemployment rate is still above 7 percent after 4 years. 

So why has the market divorced itself from the real economy?  Because of the Federal Reserve’s low interest policy that has encouraged investments in housing, equipment, factories, and to make it easier for households to keep spending. The loose monetary spending has compensated for the government tightening and increase in taxes. Bond yields are so low that investors who used to keep money in CDs, Treasuries, and Money Markets are being driven into the stock markets in search of positive after tax and inflation returns. Market rallies can be self-perpetuating. The higher the market goes, the more stocks people want to buy. 

We are in a different type of goldilocks economy. If the economy slips back into recession, even the Fed will not be able to keep the market afloat. If on the other hand the economy begins to really expand and reduces the unemployment below 7 percent, investors will sell bonds in anticipation of Fed reversal which will drive up interest rates and possibly push down stocks. This may be a good scenario for the economy but disastrous for bonds and a ceiling for stocks.  The only way I can see long term economic growth and market stability is the expansion of small business but they lack one primary ingredient, capital. Part of the problem is that the big banks are focused on creating investment products than their core business of allocating capital to business.  So small business and individual borrowers have trouble getting their attention and U.S. production suffers as a result.  Other than that the economy need to remain status quo or Wall Street could be in for a rough ride.
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