If you watch the news, you might feel that things look pretty dismal worldwide.
Growth appears weak, income is flat, consumer spending has slowed, and unemployment is high. (In fact, youth unemployment has reached 16 percent in the U.S. and as much as 56 percent in Spain and 62 percent in Greece.)
Meanwhile, governments are running large deficits and central banks are printing mountains of cash. College-bound kids are drowning in debt and struggling to find jobs after graduation.
But if you look at the equity markets, things appear bright and sunny. We’re near record highs, and interest rates are exceptionally low.
How is it possible that these two worlds – economics vs. financial markets – can peacefully coexist? The short answer is, they might not be able to. And I think they shouldn't for long.
Right now, the economy appears to be suffering from a lack of demand. This is a normal part of economic cycles that occur when the largest demographic in the economy (currently the baby boomers) enter the phase of life where saving becomes more important than spending. This lack of demand is compounded by a dramatic reduction in the people (other than college students) who want to take on credit.
These two trends can result in a slack economy, described by high unemployment and stubbornly low wages.
The government and the Federal Reserve have recognized this lack of demand, but they aren’t sure how to fix it. The Fed has few tools – such as controlling interest rates and printing money – so it does what it can.
This appears to be a recipe for pushing stock prices higher, because it makes other investments, like bonds, less attractive. The problem is that the efforts are not actually fixing our economy.
But the Fed keeps printing, and the markets have been rising. The problem comes in when the Federal Reserve begins slowing its efforts. This hasn’t happened yet, but the members of the Fed Open Market Committee (FOMC) discussed at its last meeting how and when this might occur.
When the minutes were made public, the market dipped.
Keep in mind that nothing had changed economically. We were, and are, in the same place as before the minutes were published. The market participants simply reacted to their acknowledgment that the Fed might actually quit printing $85 billion a month.
So it is the sluggish economic numbers that have caused a massive response by the Fed. But rather than responding to these economic numbers, the equity markets appear to be reacting to the Fed’s decisions. Thus our rising markets may not be truly reflective of a healthy economy.
It’s an odd situation, but it’s the one we face. Financial planners will watch these programs closely, because they could present clues as to when the markets could take a break from their upward trends.
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