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Stewart Cowley: disappearing foam line - this far no further!!

Stewart Cowley: disappearing foam line - this far no further!!

I like the sort of information that people ignore. The stuff that slips under the radar screen pretty much unnoticed has something more to say about our world than, for example, trying to predict the next twitch in the direction of any of the various Purchasing Managers’ surveys.

It is the arrogance of markets to think that they should, and can, place a daily corrective price on asset markets meant to represent the values of the next twenty years by “valuing” highly variable information.

The piece of information that caught my eye this time was the change in net worth of the households of the United States of America. It adds together the change in stock and bond prices along with residential property prices. This is important as feeling wealthy may just give you some confidence to go out and spend, even borrow some money. That is the life blood of the US economy; without frivolous consumerism based on borrowed money, the US pretty much doesn’t exist.

So it was with some delight that I noticed that household net worth increased by $1.4 trillion in the first quarter of 2014. With stock markets hitting new highs and house prices increasing at double-digit percentage rates each year I thought that maybe, finally, America would have recovered its portfolio value and therefore the final piece of the jigsaw would be in place for a return to normality. As a bond bear, this is important to me; with the US Federal Reserve looking more likely to finish its quantitative easing (QE) policy over the summer, yields could finally start rising towards levels that might reflect sanity.

I thought this until I started adding some numbers up going back over the past five years, since the financial crisis struck. Do that and you get something of a shock. I was expecting a dip in the value of net worth, maybe a bit of recovery after bottoming out. But what I was NOT expecting was that US households would be $13 trillion BETTER OFF than they were before 2007 - that’s nearly a whole years’ worth of GDP for the United States – or that net worth would be making an all-time high.

What’s more interesting is to ask the question “Well then – when did they cross the line and get everything back they lost in the bad years?” The answer to that is, even more shockingly, not this year – but September 2012. In other words, the US asset support system that is QE, implemented by the Federal

Reserve in a bid to support the financial system, actually out-lived its usefulness over 18 months ago. Every stock, bond and house price movement since then has just been icing on the cake – free returns sponsored by cheap money or, to put it another way, returns propelled by ever more desperate investors seeking to buy just about any financial asset so that it at least protects them from whatever inflation rate they are experiencing. To be clear; this hasn’t been a conspiracy – it’s been a policy, one that has had its day.

How do you break such news to a market without causing the thing that you most fear? The answer is “You don’t”. So, like a World Cup referee, the Federal Reserve has clearly been drawing one of those lines of foam on the grass of the asset price bubble; “This far and no further!!!” only to see it fade almost immediately and move it on a few trillion dollars each quarter.

Clearly something has to give here – total net worth is on an increasing and, arguably, unsustainable trajectory just like it was in the 2002 -2007 period. If only to restore some kind of sanity, there should be a period of consolidation or outright decline across the board. But right now all it feels like is “Here we go again…”

This has many ramifications for the global capital markets and its users, not least of which, for those seeking consistent income with the minimum of capital movements. They may be in for something of a shock. The capital value of financial assets, bonds, stocks and real estate will be tested in the post-QE period.

In that case, those who have been chasing income over the past five years in an income-less world could find that they have, unwittingly, been playing the most dangerous game in town. This is saddening because the people who depend upon the income game the most are, simultaneously, the least capable of seeing their capital decline especially if, to support their lifestyles, they are in drawing-down capital mode to top up their meagre income.

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Stewart Cowley
Stewart Cowley
43/63 in Bonds - Global (Performance over 3 years) Average Total Return: 1.52%
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