A Bright Future? Depends Where You Look

03/01/2012 7:45 am EST

Focus: MARKETS

Richard Young

Editor, Young's Intelligence Report

Things are picking up, it seems, but don't get too optimistic that our short-term turn of good fortune has the legs to go the distance, writes Richard Young of Intelligence Report.

You can be upbeat about the economy and the stock market as we move through the year. There is a lot to like over the short term, and I see solid momentum in a number of sectors.

The Luxury Goods and Transports sectors have great momentum, which is certainly symbolic of an economy with some thrust. I like that consumer sentiment in recent months has trended up. OK then: on the surface, conditions appear hunky-dory.

On the energy front, it is nice to see progress in Key West. A guy with maybe four teeth recently cruised into a local parking lot in Old Town on a hand-built trike powered by a two-panel solar rig on top and a battery in a saddlebag.

The fellow claims a range of 30 miles and a top speed of 16 mph. He told me the trike was built over a weekend with various spare parts and some items secured easily off the Internet.

My dentally challenged energy expert informed me that the raw materials for electricity and transportation (namely sun and wind) were abundant in the Keys, and that none of us need rely on the grid or imported fossil fuel.

Brilliant, and apparently beyond the scope of America’s political crowd. What a joke. How come a guy with four teeth can figure out the game?

The Digital Printing Press
Now then, let me dim the lights on the economic party. All the momentum that is clearly visible is the result of monetary bribery and malfeasance at the Fed.

The Fed and assorted US government entities hold over $6.3 trillion of US government securities. That amount is up from $2.5 trillion a decade ago. How does the Fed pile up such a mountain of securities, and how are these securities paid for? Why, the Fed simply prints money (digital printing of course) and credits the fiat money to accounts of Federal securities dealers, such as Goldman Sachs (GS).

All this money immediately finds its way into the economy and securities markets, which creates bubbles and a false sense of prosperity. So you can see that with so much liquidity in the system, there have to be temporary beneficiaries galore. And there are.

chart
Click to Enlarge

But down on the ground, a festering condition of dry rot and instability builds. A fundamentally strong economy is built on a base of solid employment and housing momentum. My chart on US new home sales has a pretty depressing look, does it not?

And employment, while clearly picking up a little momentum, has a soggy look. There are today nearly two million fewer Americans on non-farm payrolls than when the current inept government took over.

French economist Frédéric Bastiat pronounced, “Government is the great fiction, through which everybody endeavors to live at the expense of everybody else.”

Eliminate Whole Programs
Small-business owners (my clients) are not keen on expanding payrolls due to the potential negative overhang of Obamacare and a full knowledge of what is going on in Washington and at the Fed. Chris Edwards, director of tax policy studies at the Cato Institute, recently offered some pithy points that I’d like to pass on to you.

As Chris notes, “government spending transfers resources from higher-valued private uses to lower-valued government uses. Taxes impose distortions, or ‘deadweight losses’ on the economy...”

Regarding deadweight subsidy programs, Chris points out that these programs cost money, generate a bureaucracy, and spawn lobby groups, which in turn encourages more folk to expect handouts from the government.

“In many cases,” Chris maintains, “we should eliminate whole programs, or privatize activities where possible, to remove them from the federal budget altogether.”

John A. Allison Is the Man
So government intervention, far from fueling solid economic growth, is achieving exactly the opposite result. The central government’s ally in the massive economic/monetary charade is, as I touched on earlier, the Fed.

John A. Allison, former chairman and CEO of BB&T (BBT) and one of Harvard Business Review’s Top 100 successful CEOs in the world, knows a little about government intervention. In a recent Cato letter, Allison opined, “FDIC insurance has destroyed market discipline in the banking system. Most of the large institutions that failed financed their high-risk lending businesses using FDIC-insured deposits.” (Your money.)

Isn’t that just swell? Talk about malfeasance and inherent instability.

Further to the instability issue, J.A.A. notes, “The regulators used fair lending laws—designed to eliminate racial discrimination in lending—and the Community Reinvestment Act to force banks to make loans to unqualified borrowers in order to increase homeownership.” The blowback from this carries along today with a mass of upcoming foreclosures hanging over the housing market (see Miami).

So while I can indeed point to some monetary-bribery-bought, short-term benefactors in the economy, the underlying message I want to leave you with is one of caution. Payback lies ahead in terms of inflation, dramatically higher interest rates, dollar debasement, and bubble bursting. Enjoy the respite while it lasts.

Income Strategy
To navigate today’s fixed-income landscape prudently and still generate a reasonable amount of income, some strategy adjustments are in order.

There is still value in the corporate-bond market in the lower rungs of the rating scale—BBB and lower. In a yield-starved environment with economic data improving, the high-yield bond sector looks inviting. Investors can collect yields of more than 7% with the prospect of capital appreciation.

Where does the capital appreciation come from? High-yield bond spreads remain elevated by historical standards. If high-yield spreads fall another 150 basis points, which would put them near fair value, high-yield bonds could gain another 7.5% on top of the interest income, for a potential total return of 15%.

Related Reading:

The World's ten Most Powerful Cities
Dow 15,000: What it Will Take
Don't Take the Bear Bait

Related Articles on MARKETS