The stock market is up approximately 57% since its March lows. One would forgiven for assuming that investors were pouring money into equity mutual funds. Actually it is bond funds which have garnered investors' attention. Morningstar reports that bond funds have received net deposits totalling $209.1 billion while stock funds attracted $15.2 billion in deposits. Why have many investors shunned equities, especially with its sharp rise, and have flocked to bonds?
The answer is two-fold:
- Baby Boomers are aging. They will focus less on stocks and more on bonds. An aging population means more focus on bonds.
- Not everyone buys into the recovery story. In fact, it is mostly equity oriented money and fund managers who talk the V-shaped recovery story.
It is true that the bond guys have fund managers talking their books and the markets higher. PIMCO's Bill Gross is one. However, not everyone on the bond size of the business is talk a book. Art Laffer, Alan Greenspan and even Ben Bernanke, to name a few, are warning of sluggish growth once government stimulus ceases. The plain truth is that there can be no sustained strong growth or core inflation pressures (at least not at first) without job growth and either wage growth (which has been sluggish during the past two decades) or easy access to increased amounts of leverage. The Fed decided to focus on cheap leverage to stimulate the economy, cycle after cycle.
The problem with using ever cheaper leverage to reinvigorate the economy is that it is a finite proposition. After all, interest rates cannot be lowered ad infinitum. At some point rates will approach zero and the ability to stimulate the economy ceases. Another factor in the economic growth experienced during the past two decades is securitization. Securitization enables lenders other than traditional banks and finance companies to write loans to risky borrowers, securitize the loans, sell them off and loan the proceeds to new borrowers. Again, leverage is not forever. eventually these borrowers have to make payments on these loans. Paying debts would strain family budgets. The Fed's answer was to lower rates again. Wall Street would find new ways to lend to who really should be unlendable. Home prices would rise due to low interest rates and easy loan terms attracting more buyers. Now the existing borrower could refinance their mortgages and spend either the new budget surplus or spend the increased home equity resulting from Fed policy.
We have hit bottom. No longer can the Fed lower rates from here. No longer can loans requirements be lowered to the point where the unemployed were receiving credit. Wages have little chance of growing as companies keep a tight hold on expenses. The consumer is out of the game. The treasury market is right. The economy will be sluggish once again. Today's poor ADP Employment report and Chicago Purchasing Managers' report is only the beginning. I am looking for more poor data during the next several quarters.