The Fed has kept interest rates pinned to the floor at 0% for the last several years. A primary stated objective of this strategy is to stimulate economic growth. But in many ways, it is providing added headwinds for the economy to overcome.
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A clear beneficiary of monetary stimulus since the beginning of the financial crisis has been the stock market. Of course, many consumers are not enjoying the direct benefits of these gains to stimulate economic growth. According to the latest Gallup poll in 2011, only 54% of Americans had stock market investments. It is worth noting that this number has been trending steadily lower from recent peaks at 65% back in 2007. And the latest reading was taken in April 2011 just before the market collapsed last summer, suggesting that the downward trend is likely to continue into 2012.
All in all, only one half of all Americans are benefiting from the stimulus induced rise in stocks. What's more, many of these individuals have exposure to stocks exclusively through their 401(k) or other qualified retirement plans where trying to get anything but a stock exposure is nearly impossible (the cult of equities is certainly alive and well in virtually every 401(k) plan). Moreover, these are not assets that consumers can easily access anyway to support spending and economic growth.
While monetary stimulus is boosting stocks, it is severely penalizing savers and those on fixed incomes. This is due to the fact that those living on fixed incomes and have low risk tolerances are now finding it difficult to keep up with rising prices. While the inflation rate has returned to a +3% to +4% annualized rate according to data from the Bureau of Labor Statistics, the FDIC insured interest rates that savers can earn remains meager. Even when one excludes food and energy costs, consumers still struggle to clear the inflation hurdle. For example, prior to the financial crisis in 2008, a saver could easily find a 1-year Certificate of Deposit at a local bank that paid over 4% in FDIC insured interest, which represented a +1% to +2% premium over the inflation rate. Today, savers are lucky to find a 1-year CD paying much over +1%, which represents a -1% to -2% shortfall to the current inflation rate. Thus, Fed policy alone is resulting in a meaningful implied tax on the discretionary spending of many fixed-income consumers in this country.
Monetary stimulus is not only juicing the stock market at the expense of savers, it is also sucking additional money directly out of their pockets. As shown above, inflation data often excludes food and energy prices because these two measures are inherently volatile. But if the actions of the Federal Reserve are directly causing these measures to consistently rise, these two items must be included in the assessment of overall inflation, as their policy actions are causing these readings to become much more consistent and predictable. One particular segment where Fed policy is directly resulting in skyrocketing prices is at the gas pump. From the first day that the Fed began engaging in quantitative easing back in early 2008, the impact on gas prices has been profound.
Click to enlargeGasoline prices have followed a predictable trend since the first days of Fed stimulus. During QE1, gasoline prices skyrocketed by +118%. Once QE1 ended in April 2010, gasoline prices immediately dropped by -27% in a matter of months, and this occurred during what is typically the strong summer driving season. Once QE2 was delivered to the market in August 2010, gasoline prices jumped another 92% by the end of this stimulus program in June 2011. Once again, the moment QE2 ended, gasoline prices retreated another -28% in a matter of months. Finally, since the latest Fed stimulus program along with the European Central Bank's own LTRO program, we've seen gasoline prices skyrocket another +30%. What is even more irksome is that much of this rise in gasoline prices has occurred during a time when gasoline consumption has been falling. Have the laws of supply and demand been repealed? No, they've just been severely distorted by policy action.
Rising gasoline prices represent a huge drag on economic growth for the following reasons. Based on 2010 data from the BLS, spending on gasoline represents roughly 3.6% of total household expenditures. But it is a measurably more 5.4% for middle-income households and 10.8% for low-income households. Looking back at readings from 2008 when gasoline prices were last at these levels, gasoline expenditures represented 4.3%, 6.5% and 12.1%, respectively. As a result, it's not much of a leap to consider that these percentages are likely to return to these previous 2008 highs as gasoline prices continue to skyrocket well ahead of income growth. These are meaningful implied tax increases resulting directly from monetary policy to say the least.
This issue raises an important aside. If you are investing in financial markets, it stands to reason how you can capitalize on these rising gasoline prices in the meantime. Exchange traded funds like the United States Gasoline Fund (NYSEARCA:UGA) provide direct exposure, but beware the meaningful price leakage in the ETF over time relative to the underlying gasoline price. Holding shares of integrated oil companies such as ExxonMobil (NYSE:XOM) and Chevron (NYSE:CVX) are also considerations, although they do not follow gasoline prices on a one-to-one basis. Moreover, these stocks have meaningfully underperformed the recent spike higher in gasoline prices since mid December. Another alternative would be to focus on complementary opportunities. For example, the natural gas market continues to get punished despite the rise in oil and gasoline prices. And names like Ultra Petroleum (UPL) and Chesapeake Energy (NYSE:CHK) have not only endured a sustained drubbing in recent months, but they have also vastly underperformed their peers such as Range Resources (NYSE:RRC) and Southwestern Energy (NYSE:SWN) in their own right. Thus, some of these oversold names within oversold sectors may be overdue for at minimum a reversion to the mean if not more.
Overall, the Fed's insistence on maintaining a persistently easy monetary policy at all costs is having negative spillover effects on the same economy it is trying to stimulate. Not only do the stock market gains resulting from stimulus quickly dissolve away the moment this stimulus is withdrawn, we are seeing little evidence that this increased shareholder wealth is filtering its way through the economy anyway. Moreover, this same aggressive stimulus is resulting in a meaningful implied tax increase on fixed income savers as well as low-income and middle-income households. And it is precisely the spending by these consumers that needs to pick up for the economy to sustainably improve, particularly since the small number of high income earners are likely to curtail spending in their own right given the threat of rising tax rates on income, dividends and capital gains going forward.
As we approach the time for the Fed's latest policy stimulus program in Operation Twist (stealth QE3) to roll off in June, perhaps it is finally time to consider a different policy approach to see if we can realize more productive and sustainable results.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Disclosure: I am long UPL.