Time to Get Excited?!

The Dow Jones Industrial Average crept above 18,000 for the first time ever Tuesday as gas prices continued their free fall to a U.S. average of $2.37/ per gallon (according to AAA). According to most economists, huge stock gains and plummeting energy prices have and will continue to reap great benefits for a middle-class that has been struggling to make ends meet. But just as has been the case for much of the last decade, things may not be as hunky-dory as many think.

Since the stock market recovery began in March, 2009, the Fed has consistently and faithfully stepped in to rescue a swooning stock market at the first sign of trouble. Just last week, Chair Janet Yellen told us that the Fed would "remain patient" in its decision to begin unwinding the easy-money policies that have been largely responsible for the surging stock market. Is it a coincidence that we get these promises of extended support each time things start to become volatile? Moreover the Federal Reserve seems to have discovered that it is easier to restructure sentences in its meeting minutes than to restructure the economy. Correlation is rarely causation, but it is in this case.

But without getting into the debate about the longer-term risks of this monetary experiment (which we believe are substantial), it must be recognized that the overwhelming majority of the gains from higher stock prices are going to a small percentage of wealthy Americans. The Fed's explicit targeting of stock prices as a means to improve the labor market for the masses has backfired. Rather than benefits "trickling down" to the middle class, the overwhelming spoils of easy money have "trickled up" to those who own the most stock - the rich!

All the while, the middle-class continues to struggle with weak job prospects (part-time, lower-paying jobs), stagnant incomes, and higher costs for necessities like health care, education, food, and housing (rents). Lower energy prices will certainly help, but the collapse in energy prices will also result in fewer jobs and possible layoffs in an industry that has contributed disproportionately to the job gains we've seen in recent years.

Finally, I would like to make a point that does not receive due consideration by the media. The fact is, perhaps counterintuitively, that surging stock prices will likely increase rather than decrease the costs of saving for retirement for most folks. Why? Because most people, including baby boomers who are inching closer to "retirement age", remain vastly underprepared for retirement. If they are to still achieve their retirement goals, they will have to accelerate their retirement saving at a time when stock valuations are stretched (to put it mildly).

One of the most important factors in predicting future stock-market returns is the beginning valuation level. This is a fancy way of saying that investors should try to buy low rather than high. If we agree that we should buy stock prices when they are cheap, then higher beginning valuations are highly likely to yield lower expected returns over long periods of time. Unfortunately, these lower expected returns represent another burden that will be borne by guess who? All but the rich. Why aren't these cost increases incorporated into the Fed's inflation assessment?

With regard to energy prices, there is no debating the fact that lower energy prices will have significant benefits for nearly all Americans. I've seen estimates that the average family will save up to $750 per year in the event that energy prices stay where they are now. That would indeed be a very nice bump in aggregate disposable income, maybe even exceeding the amount of the payroll tax cut that expired at the end of 2012.

But there is a problem. These studies are based on savings in the event that energy prices remain where they are now. For oil and natural gas prices to stay where they are we must assume that the forces of supply and demand have ceased to function. Sure, energy prices could remain low for a period of months or even a year. But eventually, if producers are not earning back their cost of production, they will start cancelling projects. The reduction in surplus supply will stabilize prices.

I guess my overarching point is this: the benefits of surging stock markets and plunging energy markets should not be viewed as a panacea for our economic problems. The benefits of these two forces are obvious to most, but their effects should neither be viewed as unambiguously positive nor especially sustainable. Increases in consumer spending driven solely by higher stock prices (mainly for the rich) and lower energy prices (that will likely prove transitory) does not seem particularly healthy to me. As this tale unfolds we remain committed to high quality, blue-chip stocks with strong balance sheets and increasing earnings.