The US is comprised of two economies and the historic divide between the two continues to grow.
The disparity between the market's uptrend and the downtrend in disposable income is not sustainable.
Fed policy has encouraged companies to pursue short-term profits in lieu of long-term growth that widens this divide.
There will be another re-pricing of risk assets that reflects the underlying strength of the whole economy.
It is the best of times for a few. It is the worst of times for many, many more. It is an economic recovery that is gaining momentum. It is an economic recession that never really ended. Interest rates are at historic lows and home affordability is near historic highs. Yet home ownership has declined five years in a row and the number of homeless students in our public schools continues to climb. The gross figures for consumer net worth, personal income and consumer spending have fully recovered since the Great Recession to reach all-time highs. During the same period of time the number of Americans surviving on food stamps has nearly doubled, surpassing a record 48 million. Rolls-Royce just finished its most profitable year ever and Maserati saw its sales increase 55 percent. Meanwhile, Wal-Mart (NYSE:WMT) just finished a three-month period during which its sales fell on a year-over-year basis, and McDonald's (NYSE:MCD) saw its third consecutive monthly decline in business. A case of Romanee-Conti was purchased for the equivalent of $10,000 a glass, a parking spot in San Francisco was acquired for $82,000 and a painting sold at auction for an unprecedented $142 million. These indulgences accompanied the most recent budget cuts to the SNAP program that will reduce the amount a food stamp recipient is allotted to less than $1.40 per meal.
It is clear that the US is comprised of two economies and that the historic divide between the two continues to grow. One is thriving in a new expansion, while the other is still in recession. It is also clear that the stock market's rise has been in part driven by the one that is thriving, largely at the expense of the one that is just surviving, as capital continues to gain, while labor continues to lose out. Common sense dictates that this cannot continue indefinitely, yet the forces that have fueled the stock market's ascent over the past 18 months obviously view this growing divide as irrelevant for now with respect to the sustainability of the uptrend. The market simply does not care at this point, but eventually it will.
I can't recall any period in history when our benchmark indices were repeatedly achieving all-time highs coincident with a sitting President experiencing the lowest approval ratings of his presidency. This paradox is a reflection of the difference between the average and the mean. When gross personal income is reported to have risen to a new record amount each month, Wall Street celebrates what it construes as an increase in spending power for the average consumer, and the market goes up. What the polls reveal is that despite this rise, mean income is falling, because all of the increase has gone to the wealthiest Americans. Nine out of ten Americans see a decline in their real incomes, and their view of our leadership follows suit.
It is the disparity between the market's uptrend and the downtrend in real disposable income for the majority of households that I think should cause investor concern. This economy reminds me of the soccer team my son played on last year. He was just a beginner on this team of ten, and so were the other players, with the exception of the coach's son. He was a player. He scored all the goals. The team won every game with the exception of the one that the coach's son didn't play. The team had a phenomenal record, but it was not what you would call deep. This economy is as deep as my son's soccer team, and even more susceptible to a loss, as most of its players are sitting on the bench. How much longer can one of us earn and spend at a very solid clip while the other nine suck wind in hopes that the overall economy grows at a measly 2%?
This stall-speed rate of economic growth will not support the level of revenue growth needed to meet the expectations for corporate profits this year or the next, even if margins are maintained. As a result, the pursuit of short-term profitability has become an epidemic in corporate America, rather than strategies geared toward the type of long-term growth that is consistent with the Fed's mandate to promote maximum employment. The Fed is to blame for this turn of events by establishing the stock market as a proxy for the health of the economy. Last month AIG reported a surge in profits, so it announced intentions to buy back $1 billion worth of stock, raise its dividend by 25% and lay off an additional 1,500 employees. These activities do little to help grow the economy, instead widening the divide between the two economies that exist today.
When I think about the parabolic move in stock prices that has accompanied stagnant to declining real disposable income for the majority of American households, I am reminded of the parabolic move in home prices in the mid-2000s that led to unprecedented multiples above median household income. Home prices were not sustainable without a commensurate rise in income to support the carrying cost of the outstanding debt. I do not think stock prices are sustainable without a commensurate rise in disposable income to support the economic growth rate necessary to sustain profit growth. What seems certain is that our two economies will eventually collide and the growing disparity will resolve itself in one of several ways.
One solution would be to put the three guys that bought the case of wine, the parking spot and the painting in a room with 97 hungry food stamp recipients and let them duke it out. That's the way these imbalances are inevitably "worked out" in third world countries, but I would hope for a more civil ending than that. A more palatable alternative would be to implement structural reforms and fiscal policies that stimulate the type of brick-and-mortar economic growth that leads to a rise in real disposable income for the majority of Americans. Unfortunately, the likelihood of that happening over the next three years is zero, which leads me to one remaining alternative. There will be yet another re-pricing of risk assets that reflects the underlying strength of the whole economy. Perhaps the third time will be the charm.
The late George Carlin used to jest during his comedy shows that the reason they called it the "American dream" was that you had to be asleep to believe in it. What's sad is that he wasn't joking around. I'm still hopeful that we can get our act straight and rebuild this economy from the bottom up, rather than repair a broken system from the top down.
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.
Additional disclosure: Lawrence Fuller is the Managing Director of Fuller Asset Management, a Registered Investment Adviser. This post is for informational purposes only. There are risks involved with investing including loss of principal. Clients of Fuller Asset Management may hold positions in the securities mentioned in this article. Lawrence Fuller makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Fuller Asset Management. There is no guarantee that the goals of the strategies discussed by will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security.