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Connecting the Dots

by on July 21, 2013 6:00 AM

In the world of investment management, thoughtful analysts usually work to align the performance of the stock and bond market with the progress being made in the broader economy. I am often looking for the conditions of sustainability in economic policies and performance to buttress the performance of the investment markets. Now, Dad never said it would be easy when I joined the firm 48 years ago, but under the current conditions a dichotomy has arisen, giving me serious pause when I am investing money for the long term. My concern is that the macro policies of the government and the Federal Reserve are not sustainable and will eventually fail both the consumer and the investment markets.

More than other first world countries, our economy is driven by the consumer. Consumer spending makes up just over 70% of our annual Gross Domestic Product (GDP). Therefore, as the consumer goes so goes the overall US economic growth as measured by the rate of change in the GDP. Much of the rest of the world is export driven; dependent on foreign consumers somewhere else in the world (usually in the United States) to support their economies. So, for us, it all boils down to the financial health of our consumers from the poorest to the wealthiest. Since 2008 we've not been very financially healthy.

Consumer financial health can be measured by both employment data and by the income generated by the working population. Since June 1, 2009, Nonfarm payrolls have grown less than 5 percent, while the growth of the food stamp program is up well over 30 percent.

Measured other ways, Real Disposable Personal Incomes have risen 1 percent this year as opposed to just over 3 percent in prior recoveries. This is a reflection of two things: the fact that the vast majority of jobs that have been created in this recovery are in the low-wage retail, leisure and hospitality industries, and the steady growth of part-timers.

So the real driver of the economic engine of the United States is essentially in neutral. Looked at another way, Wall Street analysts lament the lack of sales growth in private industry, even as earnings rise sharply through cost containment policies. Eventually you run out of costs to contain and must have sales growth to maintain earnings growth. Apparently we are not yet there, but we are closer than ever before.

You might wonder why the stock market is regularly making new highs while interest rates and inflation are staying very low. As most markets observers know, it is all a matter of Ben Bernanke and the monetary policies of the Federal Reserve. Throughout this so called recovery, the Federal Reserve has been creating vast amounts of low priced money to stimulate the economy through quantitative easing programs labeled QE1, QE2 and now QE3. QE3 is designed to pump over a trillion dollars into buying government bonds and mortgages until the unemployment rate declines to 6.5%. This is an indeterminate length of time and the reason that investors and financial commentators seem to hang on every word from Ben Bernanke and the Federal Reserve. We all have a single focal point. Needless to say, this makes me very nervous as a portfolio manager because these policies are not sustainable in the long run.

The big question is when will the economy begin to grow on its own without stimulus so that the monetary easing by the Fed can be withdrawn? This is a very hard question to answer when we are committed to continuous monetary stimulus. How can one tell when it becomes unnecessary if all the indicators are skewed by the stimulus itself?! I want to connect the dots, but when some of the dots have been moved, are mis-numbered or are missing, it's difficult to get a clear picture of the economy.



Dan Nestlerode was previously the Director of Research and Portfolio Management at Nestlerode & Loy Investment Advisors in State College. He retired in 2015 after 50 years in the investment business. A graduate of Penn State University, Nestlerode became an investment advisor in 1965. He can be reached at [email protected]
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