Here Come the Wall Street Spin Doctors...

I made time this morning to work through the 200+ articles I set aside that inform us about the state of the U.S. economy. No surprise, the news isn't good. What is a surprise is the fact that the market has yet to really price in the state of the economy. What this means is that when Democrats in Congress finally move to pass healthcare reform, the markets will begin tanking sharply. The news headlines will read that the market is responding negatively to the new healthcare reforms. That will be the bullshit spin coming from Wall Street insiders. The truth is the market has been riding up a wave of b.s. for months now and is long overdo for a major selloff.

With consumer spending making up roughly 70% of the economy, it is clear that where the American household goes so goes the American economy. The average American household is not doing too well right now. Because of an underperforming stock market, 401(k)s have lost over a quarter of their value in the past decade. Existing homes sales fell 7% in January, following a 16% decline in December (the largest drop in history). Important to note that of the homes that were actually sold, 38% were foreclosure sales. New homes sales are fairing even worse, declining over 11% in January, the sharpest drop since 1963. We will not see an improvement on home sales any time soon -- new mortgage applications are at a 13-year low. Some with mortgages are wishing they didn't have one -- more than one-fourth of all Americans with a mortgage owe more than their home is now worth; also, 10% of mortgage owners owe more than 25% than their home is worth. Real unemployment is estimated at around 17% right now, with more than 40% of the unemployed being out of work for over 6 months. Unemployment and high medical expenses are contributing to increased bankruptcies -- personal bankruptcy filings are up 14% from a year ago; more than 60% of the filings are tied to medical expenses. [Healthcare reform matters.] Those fortunate enough to have jobs are also being affected by the poor marketplace -- in 2009, personal incomes fell 1.7%, the sharpest drop since the Great Depression; average income is less than it was 10 years ago.

While Wall Street banks are experiencing record profits (thanks to back-door AIG bailouts from the taxpayer), the average U.S. bank is not doing well. After 140 bank failures in 2009, well over 700 banks (or about 10% of all U.S. banks) are on the FDIC's watch list for potential failure this year. After all that has been spent on bank bailouts, it is estimated that an additional $1.5 trillion is needed to recapitalize U.S. banks (this statistic is baffling to me considering that the estimated capitalization of all U.S. banks is only $1 trillion -- nationalization of the banking system does not seem so farfetched). More than $1 in every $10 that U.S. banks have lent out is in the hands of troubled borrowers on the verge of default. Wall Street bankers are doing very well - Wall Street bonuses increased 17% in 2009 to $20 billion; compensation and benefits from the 20 largest banks were at $300 billion in 2009. The average pay of a Goldman Sachs banker in 2009 is $600,000; partners at the top 25 law firms (dealing primarily on Wall Street) earned anywhere from $1.3 to $4 million in 2008. Meanwhile taxes on high earners are at historical lows -- about half the rate they have been over the past 100 years.

The U.S. Government and state governments are also in a world of hurt. Expect massive cuts in state budgets over the next 2 years. In the state of Illinois, for example, it is projected to have a deficit of $11 to $13 billion through 2011. Public sector pensions are one part of the burden -- the 50 states are facing a $1 trillion shortfall in public sector retirement plans. Federal debt is in an even worse situation -- U.S. debt is expected to top $22 trillion over the next decade. Because of the high debt, rating agency Moody's published a warning this week that the U.S. Government's AAA-rating is in jeopardy; the U.S. has never had less than a AAA-rating. Moody's concerns center on federal debt that is expected to sit at 64% of GDP this year, additionally the U.S. deficit is expected to rise to 10.6% of GDP this year making it one of the most severe ratios in the industrialized world.

Because of do-nothing Republicans on Capitol HIll, systemic risks in the financial system remain. The combined assets of the 6 largest U.S. banks make up 63% of total U.S. GDP; 15 years ago, the combined assets from the 6 largest bank only made up 17% of U.S. GDP. "Too big to fail" financial institutions was the reason that we were told a bailout of Wall Street was needed -- yet, the numbers show that the same banks are bigger than ever before. Another major contributor to the financial crisis was derivatives. Today, an estimated $670 trillion remains wrapped up in derivatives in a shadowy and unregulated market; recent estimates put the derivatives market at 20 to 40 times the entire U.S. economy. Surely Republicans can see these problems, right? The fact that there are now 8 lobbyists for every member of Congress might have something to do with do-nothing Washington Republicans. Just a guess -- call me crazy.

So, with all of the unfavorable news widely disseminated in mainstream media, surely the stock market has priced in the negativity? Ummm, no, it hasn't. The market is basically sitting about where it was 10 years ago, yet unemployment was less than 4% then, and average income was higher then than it is today; further, our national debt has more than doubled from where it was 10 years ago. But markets are forward looking, right? So maybe the market is pricing in solid growth in the years to come? Over the past decade, growth was driven by tax cuts, tax credits, 0% interest rates and federal handouts. Today, because of unfunded spending over the past 10 years, new tax cuts and new tax credits are not possible, and federal handouts are expected to come to an end this year as the home buyer program fazes out in April. And, we are still stuck with 0% interest rates. Where will the growth come from? Who knows. But the market is definitely looking through a rosy lens right now. The S&P 500 has a PE of about 80 if we use trailing numbers over the past year. If we look to where earnings are being projected to be by 2011, as estimated by Wall Street analysts, the S&P is carrying a forward PE of anywhere from 20 to 25. Historically, the S&P has carried on average a PE of 15.7. The market must be a good deal because mutual funds currently have the lowest cash levels since September 2007, 1 month before the S&P 500 started on its 57% decline to an ultimate low of 666 in early 2009. [Hedge fund managers look at cash levels of mutual funds because hedge fund managers consider mutual funds to be "dumb" money]. Another bearish indicator -- insider selling is at a high for the year, while insider buying is at a low. And curiously, the SEC recently moved to curb short sales through a 3-2 vote; the timing is interesting -- some see it as a move in preparation of upcoming market declines.

I purposely haven't mentioned the sovereign debt crisis facing other countries; Greece, for example, has $72 billion in debt due this year and has to make severe cuts to social programs to pay the bill. The reason I haven't mentioned the crisis facing Portugal, Ireland, Greece, Spain, Italy, the U.K., and other nations, is that our country is at the heart of the global problem. Where we go as a nation, so goes the rest of the world. We must focus on fixing our problems first, and then we can worry about what other countries are dealing with. In summary, where are we at? A new financial health indicator developed by Goldman Sachs, which consists of 44 economic indicators, is projecting economic weakness in the near future. Genius. Just read the news. Where will the market go from here in light of the economic data that is out there? It will not fair any better than it has the past 10 years; adjusted for inflation, Wall Street returned a 20% loss to the average investor over the past decade. Do not expect any better than that this decade.

Peace

Jeremy