Three Reasons Wall Street is Booming; Three Reasons Main Street is Dragging

Investors on Wall Street have been doing very well over the last few years.  Even over the last few weeks, as the government shutdown took effect and various commentators warned of a “default on the economy” if the debt ceiling were not lifted, the market held up relatively well.  The average worker on Main Street has been doing less well.  This clearly shows that the stock market and the economy are not always correlated.  In fact, they often act independently of each other, or even are negatively correlated – one goes down when the other goes up.

The stock market looks at corporate earnings, future values, and factors such as inflation.  Consumers and workers look at job stability, the level of spending or business, and how valuable they feel to the company for which they work when judging their confidence in the economy.   The markets are also often concerned with predictability, so the markets may rally after taxes are raised. for example, because there would no longer be a question of whether taxes would be raised.  The consumer, on the other hand, may feel poorer when taxes rise and reduce his take-home pay.

To understand the current economy and markets, let’s look at three factors affecting the stock market and three factors affecting the consumer markets.

Factors Affecting the Stock Market:

1.  Federal reserve Policy is inflationary and stimulative.  There is an old saying to “never fight the Fed.”  This means when the Federal Reserve is keeping interest rates low to encourage borrowing and growth of the economy, it is good to be long stocks.  Likewise, when it is raising interest rates and taking money out of the economy, it is wise to take some profits and raise cash, or even go short stocks.  Low interest rates can also have the effect of causing inflation, which will eventually lift stock prices in dollar terms as dollars become less valuable.  The Federal Reserve has been keeping interest rates low and, with the economy going nowhere fast, is unlikely to be raising them anytime soon.  This has helped drive the market boom.

2.  Corporations have become more efficient, raising profits.  Because business dropped off during the last recession, businesses laid off all but their best workers.  Unable to hire workers back due to the slow economy, they have purchased technology and improved their processes to allow them to get by with fewer workers.  As the economy has come back somewhat, they have been able to produce more profit per worker, thereby increasing their profits.  Higher profits per share has caused share prices to advance.

3.  Low interest rates have forced savers into stocks.  Normally savers and people in need of current income (like retirees) would be invested mainly in CDs and Treasury bonds.  The very low interest rates, however, have forced these savers to take on more risk, buying dividend paying stocks, large cap funds, and the likes.  This has caused the price of equities to rise.

Factors affecting main street:

1.  Businesses have been slow to expand and hire more workers because of low growth rates.  The economy has been growing at a very anemic rate, causing businesses to delay expansion and hiring until the economy appears to be picking up.  In addition, the efficiency improvements and technology investments which have helped corporate profits have allowed companies to get by with fewer workers, reducing the employment rate.  Note that while the employment rate has been declining, the labor participation rate has been dropping as well.  This means that individuals are simply giving up, rather than that people are finding jobs.

2.  Regulations in the healthcare law and elsewhere are discouraging hiring.  The Affordable Care Act requires that companies that have 50 or more full-time workers provide health insurance or pay a fine.  Employees working 30 hours or more per week are considered full-time.  This has caused businesses to either not hire or convert workers to 29 hour per week schedules or less to avoid the jump in costs, which in some cases would make the workers cost more than the amount of money they produce for the company.  

Beyond the healthcare law the government has been far more activist than it has ever been.  With new environmental regulations being enacted that regulate CO2 production, new wage limits being discussed, government voiding of contracts (for example, during the auto bailout) companies are leery of hiring and expanding.  They have instead taken a wait-and-see attitude, waiting for the dust to settle so they can pick the best path in  the new regulatory environment or perhaps simply waiting for the next Administration.

3.  Fewer people are working, meaning that there is less being produced to go around and people feel poorer.  During his speech at the Democratic National Convention, President Clinton spoke of how employment rates dropped significantly during his second term after Newt Gingrich and the Republican Congress passed welfare reform which he signed into law.  This caused people who had never worked before to enter the labor market.  Because there were more people working, there were more goods and services being produced, which in turn could be traded, causing the economy to grow.  This lead to consumer confidence, resulting in more spending and a more rapid expansion of the economy.

We have seen the opposite effect since the 2008 crash with welfare rolls expanding and fewer people working.  Because a large number of people are not producing anything, there is less wealth to trade even though they are receiving benefits from the government.  This means that businesses expand slower and there are fewer jobs created.  This all leads to a weakened outlook from the consumer and, consequently, less spending.

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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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