Share Market Decline

Uncertainty has returned to the US share market. How it will end is not clear.

In the old days, the sharemarket was thought of as a market for capital assets (factories, machinery, etc). A rise in the price of shares reflected improved business profits or increased business confidence. This understanding is no longer true.

Share prices are now influenced much more by the decisions in the political and financial sectors. The American economy looks strong, with unemployment at low levels, but the financial sector and the real economy are increasingly disconnected.

• The current boom in share prices have not been driven by corporate profits, but by the low interest rates imposed by the Fed since the GFC. Debt funded share buy-back schemes have also pushed up share prices for the benefit of managers paid in stocks or stock options. Price to earnings ratios are at very high.

• After nearly a decade of close to zero interest rates, the Fed is raising interest rates. The cheap money that has sustained share prices might disappear.

• To support their quantitative easing policies, central banks bought a third of all securities, including debt and shares (socialisation of the means of production by stealth). They have now stopped buying. As the securities are maturing, they are disappearing from their balance sheets. Some central banks are actively selling.

• The bond and share markets no longer stand alone. A huge mix of financial derivatives and financial products sit on top of these markets. The value of this financial superstructure is exponentially greater than the capital assets controlled by public companies. These products are an uncertain mix of leverage, risk and debt.

• The US Congress has just agreed to a budget that involves a huge spending increase, following from tax cuts passed last month. The massive budget deficit that inevitably follows will have to be financed with borrowing. This is likely to push up interests and attract money out of shares.

• The Chinese have stopped putting most of their spare money into US Treasuries and are placing more of their surplus into One Belt One Road investments in Asia and Africa.

This is different from what has gone before. How these different pressures will work out is anyone's guess.

Weak Economy

I listened recently to a talk that Jason Furman gave at the London School of Economics on the United States Economy. He is the Charman of President Obama’s Council of Economic Advisors.

Furman presented some interesting statistics. He explained that between 1945 and 1973, the income of the bottom 90 percent of households increased by 2.9 percent per year. With this growth, their income doubled every 24 years, which means that each generation could expect to have an income twice as good as their parents, on average.

Three things contributed to the growth: substantial increases in productivity (2.8 percent per year), diminishing inequality (as the top ten percent got a significantly reduced share), and greater labour participation as woman moved into the work force (from 33 to 50 percent of working age women).

Between 1973 and 1995, the incomes of the bottom 90 percent fell slightly on average, as productivity growth halved and inequality rose. These negatives were almost compensated by continued growth in worker participation of women (to 75 percent).

Between 1995 and 2013, the incomes of the bottom 90 percent rose very slightly. Productivity grew slightly, inequality worsened and workforce participation dropped slightly. Female particpation plateaued and male participation declined.

The change increase in inequality was significant. In 1973, the bottom 90 percent of households gained 68 percent of income. By 2013, their share had dropped to 53 percent.

No wonder many Americans feel bad about their economy. Many younger Americans are going to be worse off than their parents.

Jason Furmon had no effective solutions to offer. Nothing tried since 1973 has worked.