I don't mean to rain on your parade, but…
Stocks made new recovery highs on Tuesday this week, with the S&P 500 up 64.1% from the March bottom in just 253 days. That's the fourth best rally in the recorded history of daily U.S. stock prices, exceeded only by monster rallies in 1915, 1932 and 1933.
But I really think it's over. Time to take profits. Time for a correction. Time for people to get scared again. It's the nature of the beast. It works that way.
And it reflects the reality of the world we live in -- especially if we filter out the illusions and look hard at what's really been going on. The chart below does that.
I say of the 64.1% recovery from the March bottom, only 3.1% is real. The rest is an illusion, created by the falling value of the U.S. dollar.
Here's how I do the math: 64.1% is what you get if you price the S&P 500 in dollars. But the dollar has been falling. So, yes, the S&P 500 gets you a lot more dollars than it did in March, but the dollar itself isn't worth as much. It's fallen by 15.4% since March compared to a basket of other major currencies.
Instead, let's price the S&P 500 in terms of something real. How about gold? Assets don’t get any more real than gold. Gold is at all-time highs, up 61.0% from its bottom about a year ago. Priced relative to gold's rally, the S&P 500 has added only 3.1%.
That's all this rally is really worth from the standpoint of growth, earnings and all the other metrics you have to think about when you buy stocks. All the rest you could have gotten with a hunk of yellow metal, where you didn't have to think about all that stuff. So all that stuff didn't really matter, did it?
Here's what this tells me. For about six months, from October 2008 to March 2009, we were looking at a real possibility of the end of the world. There was no certainty then that all the rescues, bailouts and stimulus would make any difference, and at that point we were starting to run out of ideas for what to try next. If things had gotten much worse, nothing would have been worth anything -- even gold, the ultimate store of value, was collapsing.
But somehow all the rescues, bailouts and stimulus worked. The world was saved. The first asset class to bottom and turn higher was gold, in mid-November last year. Stocks took months longer to get the message. But the message ends up being the same for any asset class you can name: The world isn't going to end, after all.
That's terrific news, isn't it? But for investors, it's not anywhere near good enough. It's not enough simply to know that the world isn't going to end. If you want to earn a return on your money, you have to also know that the world is going to grow. I mean really grow, sustainably grow -- not just temporary growth forced by rescues, bailouts and stimulus.
For me, the fact that stocks have done only slightly better in this recovery than gold says that real sustainable growth isn't very likely. In other words, now that we've experienced the thrill of having looked death in the face and survived, there's nothing to do next. Fine, we're not going to die. But how are we going to grow? Maybe we just won't.
It's not that we can't. But we're creating a set of conditions in this country and many parts of the world that will make growth very difficult. For one thing, we're going to have to deal with all the costs and side-effects of the rescues, bailouts and stimulus. That's going to mean decades of debt, inflation and higher taxes.
But what really worries me is the way the rescues, bailouts and stimulus seem to have created a permanently larger role for government -- and a capricious, arbitrary role at that. Consider the legislation being developed now in the House of Representatives to regulate the financial services industry, to ensure that a credit crisis like last year's doesn’t recur. Noble goal, but the price of it won't be worth paying.
The proposed legislation includes an amendment by Rep. Paul E. Kanjorski (D., Pa.) that would give the government power to break up any firm it determines is so big and complex that it poses a "systemic risk" to the economy. The idea is to eliminate the problem of government having to bail out companies that are "too big to fail," but the price of achieving that is to give the government arbitrary power to declare when a firm is "too big," and then to cut it down to size.
The amendment would give government the power to break up such firms whether or not there is anything going wrong. If you're a company like Goldman Sachs (GS) or Morgan Stanley (MS), even if you have done everything right, and everything is going just perfectly, the phone could ring someday and the government will tell you that you are being broken up for the crime of having gotten too big -- of having succeeded too much.
The text of the proposed legislation gives the company subject to the government's break-up order no legal appeal. It can only be contested in court on the grounds that the order is "arbitrary or capricious." In other words, there can be no debate about the basic facts themselves -- whether a firm is, in fact, too big.
When you penalize growth -- in this case, by signaling to companies that when they succeed too much that very success will be the signal to get destroyed by the government -- there will be less growth. And investors will pay less for stocks when there will be less growth. So the cost of capital will go up, which will lead to even less growth.
And by the way, it's all for nothing. Even if we were to break up firms that got "too big," whatever that means, that doesn't mean that the remaining parts wouldn't, altogether, still pose a systemic risk. Great. We penalize growth, and don't even get safety in return.
And don't get me started about the two different health-care "reform" bills working their way through the Senate and the House, both different and each about 2,000 pages, and both containing multiple new taxes to impose on people and businesses.
Where's the growth going to come from if we make it impossible? China is moving in the opposite direction, taking restrictions on growth off its economy. But can even China really grow when the United States, the world's largest economy, has decided not to?
In a world like that, it's a clear choice: Hard assets like gold will surely outperform paper assets like stocks.
Donald Luskin is chief investment officer of Trend Macrolytics, an economics consulting firm serving institutional investors. You may contact him at don@trendmacro.com.
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