State of the Economy October 2014

It has been a while since I’ve reflected on the economy. The last couple of years have seen steady growth, but mostly in stock prices through corporate stock buy backs. The true economy has grown at a far lesser speed. One might say that for this reason current stock prices are inflated. However, the bull run seems to continue. November and December have historically seen increases in stock prices, but what will happen when consumer buying drops in Q1FY15?

The second half of 2015 will start being affected by the 2016 Presidential Elections, which typically means that all legislation slows and until the election is done, and the winner announced, there will be a long period of uncertainty. Even if a correction happens in the first half the uncertainty will slow down the rebound.

The European economy has slowed down for multiple reasons. Some are structural and others related to uncertainty with Russia. Germany is the largest consumer of Russian gas and could cut the pipe off buying its energy from other markets, but many of the other European nations do not have that strength. The formal sanctions on Russia have mostly been a nuisance. The real penalty is from US test selling stock from its strategic oil reserves and pressuring its oil producing allies to add supply to the market. The Russian economy is solely based on energy sales and the drop in energy prices is crippling the Russian economy more than any sanctions could. In many ways Russia’s renewed military capability and ambition is not aligned with its economic base. A military is only mighty if it has strong economy to sustain its commitment.

As I look at the US economy I see a slow down in the fundamentals, regardless of the stock markets. The housing come back has stalled and even taken a step back. Unemployment gains are regional with net winners and losers. Middle class pay raises have been on hold for years. When we talk of the trickle down effect, the theory is predicated on the notion that there is actually trickle and that trickle is large enough to fuel consumer spending, which in turn drives the economy. We now have an engine coughing with a constricted fuel line. What we are currently doing is consolidating wealth at the top with negligent trickle and it doesn’t take a rocket scientist to figure out that the model will not work for long and the engine will stall. The power to make the engine turn again comes from the battery reserves and not the fuel tank. We are all proverbially in the same car and the current strategy is not optimal from a from distance travelled perspective, even thought the MPG reading might look good now.

Chairman Yellen recently spoke about her concerns on the wealth gap. The rise in stock prices through stock buy backs has made the wealthy even wealthier. The wealthiest at some point will cash out, which will cause a strong market correction. The stock held by the middle class is slower to react and will again carry the brunt of the blow. With a correction the gap will become even wider. The middle class will loose in the correction and the wealthy will reinvest in the bottom reaping the gains of the next cycle. Some times the correction is uncoordinated and that is when we have a depression and even the wealthy loose.

What the current government has failed in is outlawing inversions, limiting stock buy backs, simplifying the tax code, enabling the repatriation of wealth and reducing corporate taxes to be more inline with the global average. All these actions would increase the trickle effect as capital would need to be forced back to work at home. The administration talks about supporting the middle class, but it has been largely words. We fixed the housing catastrophe at the tax payers dime, but we did not fundamentally change anything. The nation needs leadership with long term vision and the willingness to make hard short term sacrifices. We need structural change badly. I am more republican than democratic in my views, but we need enlightened strong leadership, which we’ve been lacking for too long.

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