Connect the Dots: The Joyride’s Finally Slowing

Appeared in the Ladue News by Benjamin Ola Akande, March 22, 2018

The resurgence of the stock market has much to do with confidence in it – confidence that continued to grow following Donald Trump’s victory in the U.S. presidential election in November 2016.

But truth be told, the strategy that laid the groundwork for this remarkable ride actually originated with former chairman of the Federal Reserve, Ben Bernanke, a scholar of the Great Depression who unleashed a dramatic assault to address the 2008 Great Recession.

That assault began with the Fed cutting short-term interest rates to historical lows of 0.15 percent in January 2009. The essence of the strategy involved keeping short-term interest rates as close to 0 percent as possible to enable the U.S. economy to recover. And so it was for the next six years. In addition, the Fed bought long-term bonds and mortgage-backed securities over a 10-year period, peaking at a value of $4.4 billion in January 2018.

Perhaps the strategy can be nicknamed “the Bernanke” because it involved a relatively new monetary position, specifically designed to entice investors to stop buying bonds and to start purchasing equities and investing in real estate. It worked – as household wealth increased, leading to more consumer spending – and it also paved the way for the economic recovery we all are enjoying today.

The stock market awoke as the value of equities owned by the average American increased upward of 45 percent between 2011 and 2013. The net worth for households increased by $10 trillion in just 2013, so imagine the consequential impact on the S&P 500, which increased by more than 200 percent between 2009 and November 2016. But then the “Trump bump” happened, with the stock market increasing an additional 100 percent, now totaling 300 percent in the aftermath of the election.

Yes, the market has benefited from a higher level of confidence perhaps attributable to the election and Trump’s presidency. However, the price/earnings (P/E) ratio just before the election already exceeded historical averages by 49 percent. And now the Fed is expected to curtail the availability of easy money that fueled these good times. Given this sensitive balancing act, I myself suspect the Fed will get the job done without plunging the economy into another recession.

Not everyone on Wall Street agrees, though, which explains why we saw the Dow Jones industrial average fall 1,597 points in a single day. This panic-type selling originated from a fear that the Fed, under the leadership of its new chairman, would reverse the long streak of tepid inflation and that low interest rates will abruptly end.

The panic quickly subsided, though, and the market’s losses have been halved, although daily volatility remains. Rising yields mean higher borrowing costs for companies, and that may push the Fed to raise interest rates more rapidly, which would adversely affect stock prices. Some economists contend the stock market rise resembles a mountain climber scaling a steep slope – at some point, the “mountain climber” slows and maybe even descends a bit to regroup and regain strength, before continuing to climb.

Of course, as important as the stock market remains as an indicator of how the economy is doing, it alone doesn’t indicate economic prosperity and continued growth. Consider, for instance, these factors:

  • The U.S. gross domestic product has been expanding at an annual pace of more than 3 percent after inflation for three straight quarters.
  • Average hourly earnings rose to $26.74 in January, a 2.9 percent increase over the past year.
  • The labor market participation rate has been around 63 percent for the past four months.

Given those positive trends, I would advise long-term investors not to panic. Market corrections of 10 percent or more frequently occur. This isn’t the time to undo your entire investment strategy.

Dr. Benjamin Ola. Akande is the president of BOA Consulting and former president of Westminster College in Fulton, Missouri. He has a Ph.D. in economics and previously served as dean of the George Herbert Walker School of Business & Technology at Webster University.

Connecting the Dots: Uncertain New Year

Appeared in Ladue News on 1/25/2018

Industrialist J. Paul Getty, once identified as the richest living American, has been quoted as saying, “Without the element of uncertainty, the bringing off of even the greatest business triumph would be dull, routine and ultimately unsatisfying.”

If Getty still lived today, facing the uncertainty we expect in the financial markets in the coming months, I imagine he’d feel quite satisfied.

Fueling unpredictability in 2018, of course, are the recent passage of the federal 2017 tax cuts. Those cuts – the most sweeping update of the U.S. tax code in more than 30 years – clearly constitutes a fiscal stimulus. Its sponsors predict it will stimulate investment, encourage companies to bring back overseas funds and create thousands of new jobs. However, if that fails – instead, corporations may initially opt to use their tax savings only to buy back shares and increase dividends – then the legislation could add massive amounts to the federal debt, which might necessitate cutbacks in federal programs and lead to negative economic impact.

Businesses appear to be the big winners in the area of such cuts, with their rates dropping from 35 to 21 percent and the corporate alternative minimum tax having ben repealed. The budgetary cost of the cuts, amounting to almost 1 percent of gross domestic product, will be felt between now and 2022. There’s a lot at stake – and there’s also a lot of hope that this will work as envisioned.

Individuals may also benefit, at first, from the new tax brackets, which have been lowered to 10, 12, 22, 24, 32, 35 and 37 percent. The new arrangement also doubles the child tax credit to $2,000 and gives a $500 credit for nonminor child dependents.

But uncertainty exists here, too, as the law caps state and local tax deductions, and it essentially repeals the individual mandate of the Patient Protection and Affordable Care Act of 2010, colloquially known as Obamacare.

Questions abound. Will individuals spend their tax savings, further stimulating the economy? Will more taxpayers take the standard deduction rather than itemizing, which could impact charitable donations to the nonprofit sector? Will legislators ever find common ground on a comprehensive health care strategy that gives all of us certainty and affordability?

Adding to the uncertainty are short-term rate increases expected from the Federal Reserve. Since 2009, U.S. markets have been helped by a massive Fed intervention; interest rates have been pushed down to record lows, while asset purchases have depressed bond yields. The Fed has indicated it may raise rates three times in 2018, after three increases in 2017. Even if the Fed moves slowly, higher interest rates often lead to an end to credit cycles, as indebted companies and consumers default in greater numbers.

One other situation to watch in 2018 involves the increased scrutiny over privacy and control of our personal data. The FANG tech stocks – Facebook, Amazon, Netflix and Google (now Alphabet) – will continue to face growing pressures and restrictions such as those found in a new privacy law in Europe, the General Data Protection Regulation. The changing dynamics of net neutrality also pose uncertainty for consumers worldwide.

In sum, the U.S. economy has been undergoing what amounts to a sugar rush during the past several years. Economic history suggests that will end soon. Whether or not the tax cuts, Fed actions and other factors yet unknown will sustain the good times ranks as the defining uncertainty of 2018. Still, as author Stephen Covey tells us, “If there’s one thing that’s certain in business, it’s uncertainty.”