After having done some research I have come to the conclusion that while there might be a short-term correction, the next two years are going to be mostly bullish. This is going to be led by a strong America in some key areas as well as a paradigm shift occurring in healthcare. This shift could be exceptional enough to create an extended bubble-like bull market. I will offer the following to support my thesis.
- Sovereign debt borrowing
- Bank Debt Ratios and Financial Innovation
- Ground Floor Analysis
- American Healthcare Regulation
- Technical Analysis
Sovereign debt borrowing and maturity
According to this report by the OECD, government borrowing topped in 2009. Since the decline it has been somewhat level for the past three years.
Short of another crisis, there is very little reason to believe that borrowing will start to increase. If there is less demand for debt, interest rates will drop and this will create demand-side pressure in the equity markets as people move their cash to more profitable opportunities.
Furthermore, a decrease in borrowing will work in tandem with increased yearly debt maturing, which will result in economic stimulation as debt holders seek new opportunities for their capital.
If there is not a substantial decline, debt instruments could remain highly competitive and this would not fare well for the equity markets. However based on the redemption profiles, my expectation is that more and not less investment is going to move from government debt into the markets.
Bank Debt Ratios & Financial Innovation
Large banks such JPMorgan (JPM), Citigroup (C) are having a difficult time giving out loans right now despite having a large capacity. Some articles I have read view this as a negative indicator and normally I would agree with this assessment. The problem is there are various financial innovations currently in the market that could be a cause for the decrease in bank loans.
The new companies and services provide methods of financing and, additionally, some of them create a vetting process for ideas that banks do not implement.
Some of these venues include things like lendingclub.com, kickstarter.com, prosper.com, and indiegogo.com. Furthermore, some new opportunities are arising that allow people to accomplish goals without getting any financing at all. One such company is quirky.com, which funds and develops the ideas for inventors who get a commission for their ideas. While alone these financial innovations might not seem large, when combined, they quickly start to deteriorate traditional bank financing. Prosper.com alone has provided over 447 million in personal loans. The future of financing is not with banks but in crowd sourcing.
For the reasons stated above I believe it would be an incorrect assessment that bad deposit-loan ratios of large banks represent a stagnation or fear in the economy. The above listed services are all growing, not shrinking.
Ground Floor Analysis
When talking about economic growth we ultimately need to talk about unemployment. Talking about unemployment though is some what difficult since there a variety of issues that need to be considered. Below is a chart for Jobs added (in thousands).
In 2012, 2,193,000 jobs were added. There is much debate over labor participation rates and part of it involves the 8000 people a day who turn 65. What I was most interested in was not so much how many people were retiring but how many of those people would actually be a massive economic drain.
According to this report [pdf] nearly all retirees have non-retirement income sources.
Nearly all retirees will receive income from non-retirement income sources-including income from assets, earnings, SSI payments, and imputed rental income (Table 4). Among depression babies, 45 percent have earnings at age 67, and 5 percent receive SSI payments. In addition, 88 percent of depression babies have net assets and 80 percent have home equity that could support retirement consumption.
So while it is true that a lot of people are dropping out the work force due to retirement, a significant portion of these people will be able to support themselves and this decreases general economic stress. Under this light the monthly job creation rates can be perceived as enough to stimulate further economic activity and market appreciation.
While there is room for improvement, that room represents upward potential for equity markets because it means the market is not saturated with long positions yet because a byproduct of people gaining jobs is an increase in cash flow to markets. This might seem like a glass half full argument, but based on the previous history of job growth, there is no immediate reason to expect a large decline.
Additionally, monster.com reports an increase in payroll over the last 37 months. The quality of the Job market can also be confirmed by the fact that more people are quitting their jobs than getting laid off. Only people confident in the job market quit their jobs.
Lastly, an interesting note, according to an Article on CNN, prostitutes are reporting increased spending by their tech industry clientele.
While I will not go into a great detail on this highly politicized regulation. In the following 11 months, regardless of ultimate economic implications, the following will become true.
- Insurance companies will receive an influx in customers
- People will no longer be forced into quitting their jobs just to get Medicaid
- More people will visit hospitals before their conditions become critical
- Bankruptcies due to health care related bills will drop substantially
Having read the arguments from both sides, I believe that while the healthcare regulations will have implications on businesses, any negative consequences will be offset by positive economic stimulation; people returning to the work force and increased economic spending outside of healthcare bills due to the reduction of bankruptcies.
My thesis is also supported by a Congressional Budget Office report that healthcare costs are slowing down for the first time in 52 years.
The slowdown has occurred in both government and overall health spending. From 2009 to 2011, total health spending grew at the lowest annual pace since the government started keeping records 52 years ago, a trend that seems to have continued last year. In the 2012 fiscal year, Medicare spending per beneficiary grew just 0.4 percent. The new Congressional Budget Office data said that overall Medicare outlays grew 3 percent in 2012, the slowest rate since 2000.
This slowdown is even before the profound changes that will take effect in 11 months. Currently the U.S. spends roughly around 17.6% GDP on healthcare, more than any other country in the world. Netherlands is in second place at 12%. If my thesis is correct I project a decrease of GDP 1-2% in spending on healthcare in the next 24 months. This would translate to an additional 150 to 300 billion in additional revenue for the American government for discretionary spending.
The implications, either for the better or worse, cannot be understated. Keep in mind that even before people can get health insurance there will be a massive increase in consumer spending as sick people start moving money they had reserved for medical bills both actively and proactively to other locations. There is a strong possibility that this is already starting to occur.
This is a paradigm shift that could rip through existing economic or technical projections.
A personal favorite system of mine is Dow Theory, which uses the Dow Jones Industrial Average (NYSEARCA:DIA) and Dow Jones Transports Average. According to Dow theory a buy signal was only issued at the start of this year.
I think the Dow theory signal represents an indicator of support for economic growth. Transports generally do better when they are shipping more products, which would be the result of increased economic spending.
If we look at the Nasdaq Composite (QQQ) we see that the bottom has been pulling up to make a pretty clear bullish triangle.
I believe in the short term we are going to see more upward movement followed by a correction possibly similar to length and depth of the corrections that occurred in 2012. At around mid year we should see another strong push up that will continue until the end of the year and possibly further with all the standard short-term corrections.