Market Ignores Bad Economic Numbers as Ineffective Government Policies Impede Growth

by Victor Sperandeo with the Curmudgeon

Introduction:

After years of equity liquidations, retail investors are finally buying stocks, which is usually a bell ringing warning that we're near or at a market top. "Individual Investors Pile Into Market As Stocks Rise---Trading Volumes Climb at Discount Brokerages as Borrowing Against Portfolios Rises" was one of the lead articles in the February 22-23, 2014 Wall Street Journal (on-line subscription required).

The Journal article sites Brandon Garretson, who started dabbling in stocks a few years ago as the market began to rally. He got more serious last year after joining an online-trading forum. Now, the 31-year-old salesman of equipment to chemical plants makes about two trades an hour via his TD Ameritrade account. "I love it," said the Baton Rouge, Louisiana, resident. "You look over charts and come up with ideas for the next day. There's really not a better feeling," he said. He says he is considering quitting his job to trade full time.

Haven't we seen this play before? We certainly heard talk like that during the DOTCOM boom (and subsequent bust) in the late 1990s! Is it really different this time? We don't think so.

The market has been ignoring bad economic reports this year, which pundits blame on the cold, snowy weather. Here's a personal experience about good weather and retail sales:

Being in Miami Beach, FL from 2/7 to 2/11/14 in 81 degree sunshine, with no humidity, I was shopping at Neiman Marcus at 11 am on a Saturday morning with the intent to buy a gift. I took notice that I was literally the only shopper on the woman's floor. Certainly an extreme dearth of consumers was not due to the weather! My experience suggests that comparing same store sales in good weather states (like Florida and California) may be a wise approach to analyzing the weather vs sales, especially if you’re inclined to follow the crowd falling all over themselves to be long equities.

U.S. Fiscal and Monetary Policies go from Bad to Worse:

Certainly, retail sales were affected by the poor weather, but the question is by how much? Far more important is the future trajectory of sales. This is most influenced (as always) by U.S. fiscal and monetary policies.

Fiscal policy continues to be on hold as Congress and President Obama continued to be deadlocked with no new economic stimulus legislation passed in years. The Fed currently believes the weather is the cause of the bad economic numbers and continues to "taper" its QE - bond buying program, while retaining zero short term interest rates.

Meanwhile, Bloomberg reported that Fourth quarter U.S. Consumer Household Borrowing (i.e. consumer debt) Rose the Most in Six Years "Household debt increased 2.1 percent, or $241 billion, to $11.52 trillion, the biggest gain since the third quarter of 2007," the N.Y. Fed report stated. The level of debt last quarter was $180 billion higher than a year earlier.

This debt build-up may be good if it continues (in the short run) after the weather and consumer spending improves. Or bad, if last year's Christmas sales were the top.

The U.S. economic predictions for 2014 are mixed. Barron's February 15th cover story "The Case for 4% Growth In 2014" (on-line subscription required) is primarily predicated on a continued housing boom. On the other side are the usual suspects: Joel Skousen, Harry Dent, Jim Rogers, Marc Farber, and John Williams who predict the opposite--a continued soft U.S. economy.

Perceived positive economic fundamentals have been reflected in optimistic forecasts by the Congressional Budget Office (CBO). A February 5th CBO report predicts 2014 GDP growth at 3.14%, 2015 at 3.4%, and 2016 at 3.4%. The CBO takes a very sanguine view that there will be no recessions for the next 10 years! Well, you're welcome to believe this, but the CBO has a very poor track record indeed.

Our economic future may be dependent on the political wishes of the powers that be. The Obama Administration has a huge agenda that Congress will probably choke on. The U.S. President wants: an end to budget austerity, a 39% increase in the minimum wage (to $10.10 from $7.25 per hour- see analysis below), income equality (more taxes), no fossil fuel expansion (good-bye Keystone pipeline ), the continuation of ACA/ObamaCare (you can't keep your existing health plan or doctor) by selective changing of the law via his dictate, unemployment extensions, immigration reform (which increases the supply of workers to jobs), and many social reforms including restricting the 1st, 2nd, and 4th Constitutional amendments by executive order, and/or in secret via the NSA.

The endgame to all of the above will likely include: raising costs via increased regulations, more taxes, higher fuel and health care costs. In addition, the Obama agenda would result in much more government debt, while (the Fed) prints more paper "fiat" dollars. Let's not forget the escalating loss of freedom due to NSA snooping on innocent Americans (more on that below).

The Minimum Wage Debate and its Implications:

One recent political promotion (all over the newspapers and TV) by the Obama Administration is raising the minimum wage. This is politically desirable by both parties and many members of Congress. The negative part of this debate is that raising the minimum wage will likely result in lost jobs and increased unemployment.

Some interesting questions, which are not stated by those pushing for a rise in the minimum wage:

1. Why to $10.10 an hour? The explanation given is that number makes up for inflation lost to those on minimum wages from 1968.

2. Why is 1968 chosen as the base year for inflation calculations? It seems like an odd and arbitrary date, since the minimum wage law was proposed
by the US Socialist Party in their platform of 1932, and enacted into law by FDR in October 1938.

Analysis: Using the 1938 start date of .25 cents an hour to today's $7.25, the compounded increase is 4.57%. Yet the official U.S. CPI is 3.81% during that same time period. That's an increase in the minimum wage of 19.95% compounded annually over the corresponding inflation rate!

So why then is the "1968 date" used along with a proposed "$10.10" minimum hourly wage? Is it to catch up with inflation when the minimum wage is actually 20% higher annually over the past 75.33 years? From October 1938 to June 1968 the minimum wage increase was 6.44% compounded annually, while the CPI was only 3.07%. That's a 109.77% increase of minimum wage over CPI!

The minimum wage was $1.60 per hour in June 1968. It seems that the push for a $10.10 hourly minimum wage now is to compensate for inflation since that date (but not before?). During the June 1968-December 2013 time period, the CPI compounded at 4.30%, while the minimum wage rose only 3.39%. Therefore, the minimum wage adjustment needed to keep up with inflation (over those 45+ years) brings it to $10.10 per hour.

Now this is what is called “Cherry Picking" on Wall Street and in Statistics 101. The point of this exposé is to demonstrate that economics and equity fairness (?) have nothing to do with the raising the minimum wage. Rather, it permits unions to raise their wages, since the minimum wage is the base level for union wages. Is that good or bad for business? Consider the following facts and draw your own conclusions.

We think the proposed $10.10 minimum wage will have the effect of driving up worker costs by 39.3% ($15,080 now to $ 21,008, using a 40 hour work week over one year). This will affect fast food and family restaurants in a huge way. In a recent blog post titled, "Fast-Food Chains Aren’t as Rich as Protesters Think,” author Rick Newman says that the restaurant industry is a low-margin business that doesn’t have much spare cash in the till. The average profit margin for the whole industry is just 2.4%, according to Capital IQ, and that’s down from 3.2% in 2009, which is when the recession ended. An increase in the price of fast food (due to the minimum wage increase being passed on to customers) will cause demand to fall. If the restaurant or franchise requires a higher price because labor costs rise too much, demand will decline and the business might even close!

Meanwhile, teenage unemployment is now 20.4% and not likely to improve if the minimum wage is increased (c’est la vie)? Bloomberg reports that just one in three teens in the U.S. worked or looked for a job in January, a record-low since 1948 when the Labor Department data starts. That lack of on-the-job experience could cost future workers, who may lag behind on basic skills their parents developed waiting tables or running registers, some economists say.

Editor’s Note: This increased minimum wage justification methodology and analysis presented here by Victor has not been reported by anyone else that we know of at this time.

Sperandeo's Conclusions:

Politics rule in the end and this is the primary reason the U.S. is not solving the problem of low economic growth. The economy seems headed for more of the same sluggish growth, papered over by debt and fiat paper money creation by the Fed. Our economic quagmire and quality of life is made worse by the federal government's policy of security without responsibility or accountability (i.e. the NSA and secret United States Foreign Intelligence Surveillance Court). Yet our Constitution is predicated on providing individual freedom with responsibility.

This is the question we all should ask: "What percent of GDP should be spent by the Federal government-- 15%, 20%, and 50%?" Currently, it’s about 23% federal and estimated to be approximately 38% for states. Today, there appears to be no limit to government spending.

The talk of an Amendment to the Constitution for a budget cap merely transfers the definition of GDP to the judges (refer to the Republican appointed Chief Supreme Court Justice John Roberts' decision on legality of ObamaCare for how that works)! Without a committed cap on spending, we're likely to see more of the same economic stagnation. It's deplorable that those entities/companies with the biggest campaign contributions "win the day" on their agenda.

It seems that until we have a U.S. election where the public makes a clear choice, by voting into office pro-growth Congressmen and a new Presidential administration, this country will be "stuck in the muck." Where are the candidates who can make such positive change happen? Those that will compromise and work together to build a better future for America? And not be held hostage to big campaign contributors?

Till next time........................

The Curmudgeon
ajwdct@sbumail.com

Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1979) to profit in the ever changing and arcane world of markets, economies and government policies. As President and CEO of Alpha Financial Technologies LLC, Sperandeo overseas the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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