The financial and economic crisis after 2007 has exposed the severe limitations of the monetary policy to boost real economic growth. With another Fed meeting coming up, this article looks into some of the real economic indicators and the reasons why the Fed can do little to boost real economic growth.
Before I talk more about the real economic indicators, I would shift my focus to one of my earlier articles on what's driving GP growth in the U.S.?
According to the analysis, the GDP growth from 2009 to 2011 was largely driven by pharmaceutical and medical products, gasoline and energy goods, increase in rental or imputed rents for housing and healthcare services. Growth driven by these components is surely not healthy growth as it relates more to changing demographics-led spending. If readers look at the detailed analysis in the article mentioned, it can easily be concluded that GDP growth has come from Medicare, Medicaid and social security programs. It is also important to mention here that healthcare has been one of the biggest employers after the crisis. Therefore, it is more a demographic scenario-led growth than healthy economic growth.
So how strong is the real economic activity?
The velocity of M2 money stock, which gives the number of times a dollar is used to purchase final goods and services included in GDP, might give an idea about the robustness of the real economy. The M2V is currently at a 50 year low at 1.58. This clearly indicates that money has not been changing hands and the real economic activity might actually be worsening even after continued expansionary monetary policies by the Fed.
The limitation of monetary policy is clear here as the policymakers are trying to ease the liquidity squeeze scenario and encourage spending. On the other hand, banks and financial institutions are more risk averse and are tightening lending standards leading to relative liquidity tightening. Further, the leverage consumers are not in a position to leverage further amidst a weak job market and the vanishing of the wealth illusion coming from the housing market. The banks' unwillingness to lend is evident from the excess reserves of depository institutions with the Fed. As of September 2012, excess reserves were in the tune of USD1.4 trillion. Banks have been earning an interest of 25bps on excess reserves, which they perceive to be a better deal than lending to consumers.
The real unemployment rate is also reflective of the limitations of monetary policies to spur economic growth. I would certainly not look at the headline unemployment rate as an indicator of the job conditions. With a record number of people not in the labor force, the headline unemployment numbers are deceiving. The U6 currently stands at 14.7% and is reflective of the weak job market. Further, with presidential elections and expected policy changes, the private sector will go slow on hiring and U6 is not expected to improve in the foreseeable future.
The key question is - How has monetary policy helped the real economy?
I would say that the biggest help has come to banks and financial institutions and not in the real economy. Near-zero interest rates for an extended period is an extended bailout for banks. Consumers have been deleveraging (mostly by defaulting on debt) and lower interest rates have not done anything meaningful for the real economy.
Having said this, the policy of artificially low interest rates (negative, when adjusted for inflation) is expected to continue in the foreseeable future leading to more speculation in different asset classes. With negative real interest rates on bank deposits and even on 10-year Treasury bonds, investors will be tempted to speculate in risky asset classes in order to preserve their purchasing power.
From an investment perspective, investors need to remain invested in hard assets and risky assets as these will trend higher. I explained the need for policymakers to continue with expansionary monetary policies and government to pile on debt in one of my earlier articles. Given this scenario, liquidity will play an important role in driving up all risk asset classes.
I would consider the following stocks and ETFs for my long-term portfolio -
SPDR Gold Shares ETF (GLD) - The ETF seeks to replicate the performance, net of expenses, of the price of gold bullion. The ETF has an expense ratio of 0.4%, with net asset holdings for the fund at $65.26 billion
iShares Silver Trust ETF (SLV) - The ETF seeks to reflect the price of silver owned by the trust, less the trust's expenses and liabilities. The ETF has an expense ratio of 0.5%, with net asset holdings for the fund at $8.78 billion
SPDR S&P 500 ETF (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 Health Care ETF (VHT) - The ETF seeks to track the performance of a benchmark index that measures the investment return of stocks in the healthcare sector. The ETF has an expense ratio of 0.19%. In terms of sub sector exposure within the healthcare sector, the ETF has 45% exposure to the pharmaceuticals segment, a 16% exposure to the biotechnology segment, a 14.9% exposure to the healthcare equipment segment, and a 7.3% exposure to managed healthcare
iShares MSCI Emerging Markets (EEM) ETF: 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 cumulative mutual fund inflow into emerging markets has been higher in the last five years compared to developed markets. 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.
Eni SpA (E) - Eni is a European major, which has an excellent long-term outlook and is trading at attractive valuations. For investing in energy, Eni is a good option. Eni recently released its 2012-2015 strategic plans, which includes sale of assets to strengthen the balance sheet and also focus on big projects. The production ramp up in existing fields, trending up crude prices in the foreseeable future, a stronger balance sheet and partnership with Gazprom (OTCPK:OGZPY) for joint developments of projects are some factors which make E an attractive buy. E also offers a dividend yield of 4.8% and is currently trading at an attractive P/E (TTM) of 9.1.