Why Even Bernanke Sees Trouble Ahead
Simon Maierhofer
Just as you can't be a motivational speaker with a constant frown, you can't be the Fed President without being a 'glass half full' kind of guy. Ben Bernanke fits the bill well.
In 2005, Mr. Bernanke said that a housing bubble was a 'pretty unlikely possibility.' His judgment echoed Mr. Greenspan's assessment given in 2004 that the rise in home values was 'not enough in our judgment to raise major concerns.'
Even in 2007, Bernanke went on record to state that the Fed 'does not expect significant spillovers from the subprime market to the rest of the economy.'
I am not sure what Mr. Bernanke considers a significant spill, but what we got is more than your average Bounty paper towel can mop up.
According to Bernanke's assessment we are at the tail end of a minor spill, or are we?
Some of the comments made at the last Fed meeting certainly leave much room for concern. And when even Bernanke's outlook is less than rosy, there must be trouble looming. Let's take a look at what Ben had to say:
Fed statement:
'The staff did make modest downward adjustments to its projections for real GDP growth in response to unfavorable news on housing activity, unexpectedly weak spending by state and local governments, and a substantial reduction in the estimated level of household income in the second half of 2009.'
Interpretation:
GDP was lowered from its initial projection once again. Real estate (NYSEArca: IYR - News) remains the troubled sector and housing income is not recovering. Spending for consumer discretionary (NYSEArca: XLY - News) remains muted.
Much has been written about strategic mortgage defaults lately. Bank of American (NYSE: BAC - News) is fielding more than 125,000 calls a day from people seeking mortgage help. Hundreds of thousands haven't made a mortgage payment in more than a year.
That is hundreds of thousands of home-owners who decided that they won't pay the mortgage on an underwater home. The only way banks (NYSEArca: KBE - News) could motivate mortgage holders is to reduce the loan principal. If banks were to do just that, they'd have to report some $500 billion in losses, so they don't.
Meanwhile, the banks (NYSEArca: KRE - News) can successfully hide a big black hole, called shadow inventory while home-owners spend their mortgage money on the new iPad or flat screen TV. How does that affect GDP?
Fed statement:
'Real disposable personal income in January was virtually unchanged from a year earlier and would have been even lower in the absence of a substantial rise in federal transfer payments to households.'
Interpretation:
Despite massive government stimulus and billions of dollars freed up via strategic defaults, disposable income is the same as it was in January 2009. We look at the GDP and wonder how much of the Gross Domestic Product (GDP) is based on real economic growth?
By extension, it would be prudent to ask how much of the 75% gain in the S&P (SNP: ^GSPC), Dow Jones (DJI: ^DJI), Nasdaq (Nasdaq: ^IXIC), Russell 3000 (NYSEArca: IWV - News) and many other indexes is based on real growth? How much of the profits that financial corporations' (NYSEArca: XLF - News) are reporting are 'true' profits?
Fed statement:
'While recent data pointed to a noticeable pickup in the pace of consumer spending during the first quarter, participants agreed that household spending going forward was likely to remain constrained by weak labor market conditions, lower housing wealth, tight credit, and modest income growth.'
Even Mr. Bernanke expects household spending to remain constrained by weak labor conditions. The employment picture is the lynchpin for the U.S. economy. Without jobs, consumer spending won't see real growth, real estate will continue to fall and banks will continue to hoard money rather than lend money.
Perhaps you don't buy the whole 'new bull market' scenario but think that we could have a multi-year secular bull ahead of us. Let's see what we can learn from past secular bull markets.
Real or fake bull market?
As long as stocks (NYSEArca: VTI - News) go up, who cares if the rally is a real or fake bull? It doesn't matter until stocks go down. In a real bull market, stocks recover and continue rallying. In a fake bull market, stocks fall off the cliff.
But, even a fake bull market can last for several years. Take the 2002-07 bull market. The party went on for five years before the 2008 bear drew prices below the 2002 low.
Could this be another 2002-07-like rally?
Theoretically, it could. The optimism we see on Wall Street and in Washington has certainly returned. Now the administration and the Fed simply have to sort out who gets the credit for the recovery.
In fact, this is the same kind of sentiment that we saw in 1930. Right before the onset of the second leg of the Great Depression, President Hoover exclaimed the following:
'While the crash only took place six months ago, I am convinced we have now passed through the worst and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger, too, is safely behind us.'
Sorry, I went off track. But today's optimism does parallel the 1930s events. More importantly, many sentiment indicators have reached levels not seen since the last market top in 2007 or right before the technology (NYSEArca: XLK - News) bust in 2000.
If this is a 2002-07-like rally, however, the market will plow past those roadblocks and we have another couple years of rising prices ahead.
To see whether this might be the case, the May issue of the ETF Profit Strategy Newsletter compares today's corporate earnings, consumer confidence, Gross Domestic Product and employment picture with what we saw one year into the 2002-07 rally.
Even more important than past patterns are valuations. The ETF Profit Strategy Newsletter also looks at trustworthy and commonly used valuation metrics - P/E ratios, dividend yields, Dow (NYSEArca: DIA - News) measured in gold (NYSEArca: GLD - News) - and compares today's prices with valuations seen at historic market bottoms.
Having a 'glass half full' type of an attitude is not an investment strategy. It's simply an approach that renders you a genius in a bull market, but what happens when the market turns? Do you remember 2008?
Just as you can't be a motivational speaker with a constant frown, you can't be the Fed President without being a 'glass half full' kind of guy. Ben Bernanke fits the bill well.
In 2005, Mr. Bernanke said that a housing bubble was a 'pretty unlikely possibility.' His judgment echoed Mr. Greenspan's assessment given in 2004 that the rise in home values was 'not enough in our judgment to raise major concerns.'
Even in 2007, Bernanke went on record to state that the Fed 'does not expect significant spillovers from the subprime market to the rest of the economy.'
I am not sure what Mr. Bernanke considers a significant spill, but what we got is more than your average Bounty paper towel can mop up.
According to Bernanke's assessment we are at the tail end of a minor spill, or are we?
Some of the comments made at the last Fed meeting certainly leave much room for concern. And when even Bernanke's outlook is less than rosy, there must be trouble looming. Let's take a look at what Ben had to say:
Fed statement:
'The staff did make modest downward adjustments to its projections for real GDP growth in response to unfavorable news on housing activity, unexpectedly weak spending by state and local governments, and a substantial reduction in the estimated level of household income in the second half of 2009.'
Interpretation:
GDP was lowered from its initial projection once again. Real estate (NYSEArca: IYR - News) remains the troubled sector and housing income is not recovering. Spending for consumer discretionary (NYSEArca: XLY - News) remains muted.
Much has been written about strategic mortgage defaults lately. Bank of American (NYSE: BAC - News) is fielding more than 125,000 calls a day from people seeking mortgage help. Hundreds of thousands haven't made a mortgage payment in more than a year.
That is hundreds of thousands of home-owners who decided that they won't pay the mortgage on an underwater home. The only way banks (NYSEArca: KBE - News) could motivate mortgage holders is to reduce the loan principal. If banks were to do just that, they'd have to report some $500 billion in losses, so they don't.
Meanwhile, the banks (NYSEArca: KRE - News) can successfully hide a big black hole, called shadow inventory while home-owners spend their mortgage money on the new iPad or flat screen TV. How does that affect GDP?
Fed statement:
'Real disposable personal income in January was virtually unchanged from a year earlier and would have been even lower in the absence of a substantial rise in federal transfer payments to households.'
Interpretation:
Despite massive government stimulus and billions of dollars freed up via strategic defaults, disposable income is the same as it was in January 2009. We look at the GDP and wonder how much of the Gross Domestic Product (GDP) is based on real economic growth?
By extension, it would be prudent to ask how much of the 75% gain in the S&P (SNP: ^GSPC), Dow Jones (DJI: ^DJI), Nasdaq (Nasdaq: ^IXIC), Russell 3000 (NYSEArca: IWV - News) and many other indexes is based on real growth? How much of the profits that financial corporations' (NYSEArca: XLF - News) are reporting are 'true' profits?
Fed statement:
'While recent data pointed to a noticeable pickup in the pace of consumer spending during the first quarter, participants agreed that household spending going forward was likely to remain constrained by weak labor market conditions, lower housing wealth, tight credit, and modest income growth.'
Even Mr. Bernanke expects household spending to remain constrained by weak labor conditions. The employment picture is the lynchpin for the U.S. economy. Without jobs, consumer spending won't see real growth, real estate will continue to fall and banks will continue to hoard money rather than lend money.
Perhaps you don't buy the whole 'new bull market' scenario but think that we could have a multi-year secular bull ahead of us. Let's see what we can learn from past secular bull markets.
Real or fake bull market?
As long as stocks (NYSEArca: VTI - News) go up, who cares if the rally is a real or fake bull? It doesn't matter until stocks go down. In a real bull market, stocks recover and continue rallying. In a fake bull market, stocks fall off the cliff.
But, even a fake bull market can last for several years. Take the 2002-07 bull market. The party went on for five years before the 2008 bear drew prices below the 2002 low.
Could this be another 2002-07-like rally?
Theoretically, it could. The optimism we see on Wall Street and in Washington has certainly returned. Now the administration and the Fed simply have to sort out who gets the credit for the recovery.
In fact, this is the same kind of sentiment that we saw in 1930. Right before the onset of the second leg of the Great Depression, President Hoover exclaimed the following:
'While the crash only took place six months ago, I am convinced we have now passed through the worst and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger, too, is safely behind us.'
Sorry, I went off track. But today's optimism does parallel the 1930s events. More importantly, many sentiment indicators have reached levels not seen since the last market top in 2007 or right before the technology (NYSEArca: XLK - News) bust in 2000.
If this is a 2002-07-like rally, however, the market will plow past those roadblocks and we have another couple years of rising prices ahead.
To see whether this might be the case, the May issue of the ETF Profit Strategy Newsletter compares today's corporate earnings, consumer confidence, Gross Domestic Product and employment picture with what we saw one year into the 2002-07 rally.
Even more important than past patterns are valuations. The ETF Profit Strategy Newsletter also looks at trustworthy and commonly used valuation metrics - P/E ratios, dividend yields, Dow (NYSEArca: DIA - News) measured in gold (NYSEArca: GLD - News) - and compares today's prices with valuations seen at historic market bottoms.
Having a 'glass half full' type of an attitude is not an investment strategy. It's simply an approach that renders you a genius in a bull market, but what happens when the market turns? Do you remember 2008?
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