People like to think of free markets as being just that – free from external influence. I’m not approaching this as a hysterical conspiracy theorist predicting the demise of all fiat currencies and a gold standard, but from a pragmatic (and now proven) political/impact assessment standpoint. The reality is, the stock market was not allowed to fail for reasons that should have been completely obvious at the time, but are now being proven with both actions and historical returns. I’m glad I stayed 100% long equities, but in retrospect, I should have begged borrowed and stole (OK, not stole, but margin, options and other leverage) to further partake in an unprecedented 100% return of major indices in a 2 years period.
How Governments Forced Markets Higher
Governments globally cooperated (or conspired depending on which word you choose) to pump markets full of liquidity, backstop failures in large institutions and even EU member states with guarantees and essentially prevent further declines in equities. We saw the US try to forestall declines in housing with Trillions of dollars in bailouts, Fannie/Freddie guarantees, mortgage modification programs, zero interest rates, cash for clunkers, and even the 2011 energy tax credit which was partially extended from the 2009-2010 program. While the net benefit of many of these programs is questionable at best, the actual impact was to essentially pull forward Billions in spending in exchange for a increased debt servicing burdens down the road. Essentially, over the past 2 years, consumer spending has been artificially stoked in epic proportions, thus boosting equity returns the likes of which we’ve never seen.
Why Governments MUST Continue to Force Stocks Higher
So much for free markets. As much as I question valuations, fundamentals and future debt problems for the economy at large, governments will continue to force equities higher. The reason is the stakes are too high to let them fall. See, Trillions of dollars in pension plans, retirement plans, state and municipal budgets, not to mention wealthy investors – all have a lot riding on equities returns. With virtually every state’s pension plans underfunded, rather than fessing up and increasing taxes or cutting spending, they’ve simply resorted to boosting their projected annual returns in some cases to 8.5% or higher. After a 100% runup in equities, reasonable investors in a vacuum shouldn’t expect 8.5% per year in the near term, but that’s what states and municipalities are projecting. Furthermore, as TARP and other government guarantee programs come into the black as equity prices increase, it makes the bailout history appear to be more palatable (and thus, set the stage for future bailouts). After all, if we lost Billions on the bank loans, during the next financial crisis, it would be difficult to shell out that kind of money again. But at the moment, we’re showing break-even and even profits for various facets of the bailouts due to skyrocketing equity prices. So, next time a Too Big to Fail bank is ready to fold, politicians can now look back and point to the profit the Treasury realized last time around.
So I’m not a permabull citing natural reasons equities should climb from here. I’m a reluctant participant along for the ride, finally accepting of the role our government has taken on in forcing equities higher at least for the next year to two. I do believe our reckless debt burden will eventually come home to roost and by the time it’s reflected in higher interest rates it will be too late to course correct. But that is now likely years off – which will make it even more dire when the time comes. But with an election year coming up for Obama, you can be sure there will be even more efforts, either overt or covert – to continue to push equities higher. Voters’ retirement accounts, state budgets and pension plans are counting on it!
What Are Your Thoughts?
This has been a guest post by Darwin. He is an engineer and MBA who takes an “evolutionary” approach to finance, writing about adapting to evolving financial management, tax, investing, and savings opportunities. Making more money and saving more money is an adaptive process – join the evolution! He blogs at Darwin’s Money and ETF Base.