Salient to Investors:

Gary Shilling at A. Gary Shilling writes:

  • The Fed usually starts raising the federal funds rate before economic expansions are very old but this time will wait until the wave of de-leveraging, and the related slow growth, has ended. De-leveraging after major financial crises usually takes a decade to complete, so this one has 4 or 5 years to go.
  • Continuing annual growth in real GDP of 2 percent compares with a rate of 3.4 percent since WWII through 2007.
  • Treasury yields are more likely to go down than up because persistent slow growth, gridlock in Washington, business uncertainty, and ample supplies of capacity and labor on a global scale mean the US employment situation will remain weak.
  • The Fed’s unemployment rate target of 6.5 percent is becoming less meaningful because the decline in joblessness has been primarily the result of a falling labor participation rate, not rising employment. Excluding the participation rate, the unemployment rate would be 13 percent.
  • Deflation is only being forestalled by huge fiscal and monetary stimulus, but the stimulus has been replaced by fiscal drag, resulting in the shrinking federal deficit. Fed tapering won’t tighten credit by reducing excess bank reserves.
  • With inflation close to zero, it won’t take much to rattle the economy.
  • The gap between investors’ focus on Fed largesse and their lack of interest in slow economic performance is unsustainable. There has been a close correlation between the rising S&P 500 Index and the expanding balance sheet of the Fed since it started flooding the economy with money in August 2008. Expect a shock to end the Grand Disconnect and perhaps push the economy into recession.
  • Corporate profits may not hold up in the face of persistently slow sales growth, lack of pricing power and increasing difficulty in raising profit margins.
  • A substantial drop in stock prices will benefit Treasuries as they are the ultimate haven.
  • The S&P 500 corrected for inflation remains in a secular bear market that started in 2000. The PE ratio on the S&P 500 is 34 percent above its average of 16.5 going back to 1881, and has been consistently above trend in the last two decades, so probably will be below 16.5 for years to come.
  • Profits are at a record high as a share of national income as US businesses cut labor and other costs, but further productivity growth is no longer easy to achieve. Neither capital nor labor has the upper hand indefinitely in a democracy, and compensation’s share of national income has been compressed while profit’s share has leaped.
  • Corporate earnings are vulnerable to the probable strengthening of the dollar, which would reduce the value of exports and foreign earnings by US multinationals.
  • Expect further declines in Treasury yields as this bond rally of a lifetime will end but not yet.

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