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We're heading for a downturn on global stock markets. Here's why the math is ugly.
Editor's note: On Mar. 9, 2009 Boston money manager Andrew Parlin wrote a column on GlobalPost that called the bottom of Wall Street's crisis-ridden slide. Since that day the S&P 500 Index has risen about 75 percent. So when Parlin said he's had a recent change of heart, we listened. Here's an edited version of what he recently sent to his clients.
BOSTON — Until well into 2009, the highly stimulative monetary and fiscal policy initiatives implemented around the world were met with widespread skepticism. Few thought they would do little more than arrest systemic failure in the global banking system. Most projected a limp recovery at best. Even ingrained optimist Warren Buffett foresaw a U.S. economy “in shambles throughout 2009” and “probably well beyond.”
As we now know, the vast majority of investors and forecasters totally underestimated the impact of what amounted to a pro-growth policy shock last year.
A global economic recovery is now underway, with last summer marking a turning point. In nearly every major economy, purchasing manager indices continue to point higher, industrial production is in sharp recovery, export growth is accelerating, capital expenditure is gaining traction, auto sales are booming, broad-based retail activity is strengthening, and many of the sickest housing markets around the world are stabilizing.
It's time to get out of the stock market.
A self-sustaining global economic expansion is at risk. Although the troubles brewing are unlikely to become widely evident until later this year, markets have a long nose. Remember, markets made their March 2009 lows amidst utter despair over frozen credit markets and massive job losses around the world. This was several months before the first tentative signs of economic improvement. Likewise, markets may now be making a major top as an odd mix of hope and complacency has replaced skepticism and fear.
One thing is for sure: markets do not stage 70-100 percent advances in just 14 months in the absence of an enormous appetite for risk.
The $14-trillion U.S. economy, almost three times larger than either Japan or China, is widely perceived to be back on track. The key assumption is that the American consumer is once again ready and willing to do the heavy lifting and power the economy forward. With consumption accounting for 70 percent of the U.S. GDP — double what it is for China — forecasting future spending activity is crucial.
But there are reasons to be pessimistic about this consumer boost to economic growth.
Let’s step back and revisit the well-known story. Owing to the long-term decline in interest rates and the relaxation of credit standards over the past 30 years, Americans saved ever less and bought more than they could afford. In the last stages of the great consumer binge, they used their homes as a source of income, sucking equity out of their largest asset in order to keep spending.
From World War II until 2008, Americans had equity in their homes accounting for 60-80 percent of the value of that home (meaning mortgages accounted for the rest of it). Following the 2008 collapse, that picture was turned upside down. Banks now own more than 60 percent of the average American home.
In addition, the catalyst for another slowdown in consumer spending is likely to be higher taxes at the local, state and federal levels.
A Mar. 15 Barron’s cover story nicely details the roughly $2 trillion state and municipal pension fund shortfall. The article cites a Pew Center survey asserting that “eight states … lack funding for more than a third of their pension liabilities” while “13 others are less than 80 percent funded.”
Then there are the state and local budget cuts being enacted in the face of tax revenue shortfalls.
In the past, state and local fiscal woes typically occurred in isolation. Now the problem is a national blight. Governments are responding to underfunded pensions and budget deficits by raising sales, property and income taxes.
The fiscal picture at the federal level is also grim. The huge wealth disparity that has evolved over the past 30 years poses a serious problem for prospective consumer activity. According to the IRS, the top 1 percent of earners accounted for 8.5 percent of total adjusted gross income in 1980. Having risen steadily over the past three decades, the top 1 percent of earners now account for 22 percent of total income.
In 1980, the top 1 percent paid 19 percent of all personal federal income taxes. Not surprisingly, given its giant share of national income, the top 1 percent now pays 40 percent of total personal taxes at the federal level. The top 10 percent of earners pays a staggering 71 percent of total taxes.
In an effort to reduce unsustainably large annual budget deficits, there will be mounting pressure to cut spending and raise taxes. It is beyond question that the tax burden faced by upper income America will escalate dramatically. With a small percentage of upper income earners driving a disproportionately large portion of spending, it is hard to see how U.S. consumption, 27 percent of the world economy, will show longer term resilience. Even in the face of a pickup in job creation and vigorous growth in exports and business investment, the math is ugly.
Moreover, the notion that small business will somehow escape higher taxes is misplaced.
While various tax credits designed to help small business have received a lot of publicity, these will be more than offset by the upcoming tax regime changes. Half of profits generated by small business are paid at the personal level, not under the corporate tax structure. Perhaps this helps to explain why confidence at the level of small business remains relatively subdued.
On the macro front, things are also troubling.