Bill Gross' November Investment Outlook is a must read. In this piece, Gross alludes to Macbeth's "out, out, brief candle" soliloquy to describe his own fear for the future. This is a very powerful analogy. It seems there is a looming, apocalyptic mood to the markets, as indicated by the steady increase in the VIX. There is a foreboding sense that once stimulus recedes there will be a day of reckoning, when consumer spending will plummet, inflation will surge, and the dollar will crash.
The quote from Macbeth most fitting to our current situation is "our yesterdays have lighted fools the way to dusty death." Policymakers have turned to the same economic growth that got us here in the first place. Our growth in the last decade has been based on rising asset prices (and borrowing against these assets). It is eerie how closely increases in housing and stock prices are correlated with consumption. Gross:
"A long history marred only by negative givebacks during recessions in the early 1990s, 2001–2002, and 2008–2009, produced a persistent increase in asset prices vs. nominal GDP that led to an average overall 50-year appreciation advantage of 1.3% annually. That’s another way of saying you would have been far better off investing in paper than factories or machinery or the requisite components of an educated workforce. We, in effect, were hollowing out our productive future at the expense of worthless paper such as subprimes, dotcoms, or in part, blue chip stocks and investment grade/government bonds. Putting a compounding computer to this 1.3% annual outperformance for 50 years, produces a double, and leads to the conclusion that the return from all assets was 100% (or 15 trillion – one year’s GDP) higher than what it theoretically should have been. Financial leverage, in other words, drove the prices of stocks, bonds, homes, and shopping malls to extraordinary valuation levels – at least compared to 1956 – and there could be payback ahead as the leveraging turns into delevering and nominal GDP growth regains the winner’s platform."
The Fed, US Treasury, and Congress have turned to the same kind of growth to get us out of our recession--growth based on increasing demand for paper, not building productive assets as the Chinese have done. The policies of the crisis--TALF, TAF, PPIP, TARP, guarantees of debt and money markets, low interest rates--all effectively raised asset prices, either by directly purchasing assets or providing excess liquidity to markets.
The 60% surge in stocks since March clearly doesn't reflect underlying economics, as valuation ratios indicate. Even the rise in housing, which is still tenuous, is unrealistic. Robert Shiller recently said the rebound in housing prices is the strongest in 100 years, which makes no sense considering record foreclosures and unsold housing data. Again, government stimulus in the housing sector, which consists of first-time buyer tax credits, quantitative easing to keep mortgage rates low, and liquidity to MBS markets, raised the prices of these assets rather than addressing the underlying supply-and-demand economics.
This Monday, Obama spoke in a cabinet meeting about achieving "post-bubble sustainable growth." With an economy so dependent on asset prices, this transition is not going to be easy. It may not even be possible. Britain found itself in a similar situation in the early 1900s, when it realized its economy had shifted from an industrial economy to one based on "paper." For Britain, the day of reckoning Gross fears never occurred. Instead, global influence, the value of the pound, industrial output, and overall economic clout languished gradually, in the words of Macbeth, "creep[ing] day-to-day, till the last syllable of recorded time."
