Has Krugman Really Won?

Includes: EEM, JNJ, SPY, VCLT, VDE
by: Disruptive Investor

Last week, Yahoo Finance published an article - "The Economic Argument Is over - and Paul Krugman Won."

In this article, I will discuss some important reasons for believing that the stimulus vs. austerity debate, which sparked off after the financial crisis of 2007, is far from over. It's just too early to declare that Krugman, who batted for aggressive government stimulus, has won the battle. More importantly, the parameters used to judge the victory need to be looked at again and investigated at a deeper level.

Just as an example, the civilian unemployment rate has declined to 7.6% in March 2013 from a peak of 10% in October 2009. The improvement seems significant when analyzed on a standalone basis. When combined with other facts, the real picture is evident. The U6 rate, which includes marginally attached workers and part-time employed workers for economic reasons, still remains uncomfortably high at 13.8%. Without doubt, the U6 rate has improved. However, the difference between the headline unemployment rate and the U6 rate is reflective of a relatively weaker economic scenario than the headline unemployment rate might be suggesting. Another important indicator is the number of people not in the labour force. People not in the labour force have increased by nearly 13 million from the beginning of 2007, and it stands at a record high of 90 million in March 2013. An increase in individuals not in the labour force brightens the headline unemployment number. From an economic perspective, it represents a challenge as the dependent population ratio increases in a weak economic environment. This point is reflected in the civilian labour force participation rate, which is at a 30-year low and stands at 63.3% in March 2013. A holistic view of the employment scenario is therefore bleaker than suggested by the headline unemployment rate. Again, there is no doubt that the economic scenario has improved since the Lehmann collapse and the subsequent credit freeze. The key question for analysis would be - How much of the economic growth has been due to expansionary monetary policies of the government?

A few more data from the banking and financial sector might help in answering this question. The velocity of MZM money stock, which can be thought of as the rate of turnover in money supply, gives a good indication of the real economic activity. For the first quarter of 2013, the MZM was at 1.382, which is the lowest reading since the 1960s. Clearly, real economic activity is meaningfully sluggish and it is always advisable to take the government published GDP data with a pinch of salt. It is also interesting to note that while the economy seems to be improving, the number of people enrolled in the Supplemental Nutrition Assistance Program (SNAP) has surged by nearly 8 million in the last three years.

Another critical factor, which supports business and economic growth, is the lending by financial institutions. One of the primary reasons for keeping interest rates artificially low (negative, adjusted for inflation) is a boost in credit growth. Unfortunately, that objective has not been met. The excess reserves of depository institutions with the Fed have ballooned to $1.7 trillion as of March 2013. In other words, the Fed is trying to boost growth by slackening lending standards while the banks have been tightening lending standards. Banks find it safer to park excess reserves with the Fed and earn a 25bps interest than lending the money in a very uncertain economic scenario. This data questions the effectiveness of keeping interest rates artificially low. It is worth mentioning here that the adjusted monetary base in the United States has topped $3 trillion as of April 17, 2013. As expansionary monetary policies continue, doubts linger on its effectiveness on the real economy. Without doubt, asset markets have benefited from expansionary monetary policies.

There are no two opinions about the fact that the 2007 crisis was one of the worst after the great depression of the 1929. It however remains to be seen if expansionary monetary policies do bring in stable economic growth in the long term. The "Austerians" will still argue that the current crisis has just been postponed to a later date and will resurface as a bigger crisis. Just as we need to give time to the economy to recover after the crisis, we also need to give time to this debate before the final victory is announced. We might just still be in the first lap.

Amidst all this, excess liquidity in the financial system will continue to boost asset markets. I have discussed the prospects of a meaningful correction in equities in several of my earlier articles. Over the next 3-6 months, investors can consider exposure to the following stocks and ETFs:-

SPDR S&P 500 ETF (NYSEARCA:SPY) - It has been proven that beating the index is not an easy task. Therefore, the strategy should be simple -- beat the index or invest in the index. From this perspective, SPY looks interesting. The ETF provides investment results that, before expenses, generally correspond to the price and yield performance of the S&P 500 Index.

Vanguard Long-Term Corporate Bond ETF (NASDAQ:VCLT) - I am suggesting the VCLT as I believe that quality corporate bonds are a relatively better risk-free investment compared with government bonds (especially long term). The ETF seeks to provide a high and sustainable level of current income through investment in high-quality (investment-grade) corporate bonds.

iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) - Global diversification is necessary and exposure to emerging markets is critical. Over the long term, emerging markets will outperform developed markets in terms of equity price appreciation. The iShares ETF corresponds generally to the price and yield performance, before fees and expenses, of publicly traded securities in emerging markets, as represented by the MSCI Emerging Markets Index.

Johnson & Johnson (NYSE:JNJ) - is a good investment option. I like this highly diversified healthcare company, with products as well as regional diversification. Further, the sector catered to by JNJ is not very prone to economic shocks. JNJ has been a good dividend payer in the past, with a dividend yield of 2.6%. In my opinion, the stock is excellent for a long-term portfolio. It also commands a higher rating than the U.S. sovereign rating.

Vanguard Energy ETF (NYSEARCA:VDE) - The ETF seeks to track the performance of a benchmark index that measures the investment return of stocks in the energy sector. With a low expense ratio of 0.19%, the ETF is a good investment option in a sector, which has good upside potential in the long term considering incremental demand from Asia and continued expansionary monetary policies.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.