I also show in that earlier article that this high correlation between consumer confidence and the stock market has been consistent over longer stretches, with minor and major peaks in consumer confidence coinciding with market tops and bottoms in consumer confidence coinciding with market lows. Below is another chart, comparing the U.S. stock market (S&P 500) and the Univ. of Michigan’s Consumer Sentiment Index over the past nine years.
And while we might expect there to be a general trend between these two indicators (since they would tend to rise and fall together with underlying economic contraction or expansion), the correlation over both long and short periods is remarkably high, much higher than the correlation with the underlying economy (which the stock market is, in fact, supposed to reflect). Over these nine years, the correlation between this index of consumer confidence and the U.S. stock market is an astounding 88.9%, showing, if not perfect correlation, then nearly so.
In contrast, the graph below shows how consumer confidence correlated with government-reported economic growth (Gross Domestic Product, or GDP) over the same nine year period (using quarterly data for both indexes). Unlike the previous graph we see that stated economic growth data has little correlation with consumer confidence. Sharp improvements in consumer confidence often occur during economic slowdowns and declines in consumer confidence and vice versa. Looking at the graph it appears there’s hardly any correlation between economic growth and consumer confidence. And that’s because there’s not, with a correlation between these two indexes over this nine year period of just .097, indicating almost no correlation. Put another way, compared to economic growth, the correlation of consumer confidence to the stock market is about nine times higher.
What is happening of course, is that consumer confidence is reacting to the stock market, not underlying economic conditions. Besides putting the reliability of government statistics like GDP into question, it also points to the driver of the economy, and the increasing dependence of the economy upon a booming stock market. The last nine years of interest rates below 1%, by far the longest period since WWII (see chart below), has encouraged a massive wave of spending of debt accumulation and spending to flow through government, the stock market, bond market and Wall Street, as well as the mortgage and real estate market, the auto market, the student loan market, and others.
While Fed officials might publicly proclaim that their intention with extremely low interest rates is not to boost the stock market (although they have, in fact, referenced that benefit, and associated “wealth effect” as a positive “side effect”), we know that in the long run, low interest rates do not bring lasting improvements in economic growth and productivity (for more on that, reference Japan). Actually, quite the opposite. Artificially-lowered interest rates restrict the necessary saving and capital formulation necessary for productivity and sustainable economic growth. Below-market interest promote malinvestment, overconsumption and economies overly dependent upon very low interest rates and economic bubbles. In the short and intermediate-term, zero and negative interest rates will lead to more economic activity than would otherwise be the case, in the form of expanding financial bubbles, overconsumption, and debt, but in the long-run, they cause poor investment, fragile financial markets, severe financial panics and an ever-increasing debt burden which weakens the economy, the financial markets, and long-term economic growth.
Unfortunately now, the Federal Reserve (and its associates in the federal government) need ever larger and more expansive bubbles to inflate the economy enough for the outstanding debt from previous bubbles to be serviced. Each bubble creates enormous amounts of debt that cannot be serviced once those bubbles break. And with massive amounts of debt carried forward into fragile and weak economic conditions, the only possibility is to use very low interest rates to make debt-service easier, and perhaps more importantly, to create financial bubbles to create enough economic growth (even if temporary) to sustain that debt. Unfortunately, the side effect of such very low interest rates is to create even more debt. More debt in turn requires even bigger financial bubbles, and thus, the cycle continues with ever escalating bubbles and devastating financial crashes.
Over the last two decades we have seen the government and Fed intentionally use the stock market as an asset bubble vehicle. In recent years it has used zero percent interest rates (and the threat of ever-lower interest rates) to keep trillions of dollars flowing into the stock market. I have written before about the levity of the stock market in recent years, where (government-reported) 20% economic growth over several years is matched with a 100% gain in the stock market.
Today the median price-to-revenue ratio of the U.S. stock market is by far the highest it has ever been. The Schiller P/E ratio is near 29, the highest it has ever been aside from the 1929 market peak and the dot-com bubble of the late 1990s. (For more on this, I will again refer you to John Hussman and his excellent work on historical and current valuation). Earlier this week the U.S. stock market went down more than 1% for the first time in more than six months. Such an uninterrupted stretch of such a negative day had not happened in more than 20 years. This is how managed the stock market has become. Investors are now so extremely bullish and brazen without an ounce of fear because they have been guaranteed near-zero interest rates for as far as the eye can see. Interest rates far below the rate of inflation do not teach prudence and appreciation for risk. They teach speculation, and allow it for a cheap cost.
Since the bursting of the last bubble and beginning of the 0% interest rate scheme, there has been the inevitable buildup in debt in autos, along with the incredible increase in student loan debt, nearly tripling in a decade. (The latter has also been helped by the weak job market in the real economy, encouraging students to go into more debt instead of into the workforce).
The Federal government has also been willing participants in this orgy of debt and deficit spending, adding more than $10 trillion in less than a decade (see chart below). And as I commented recently, what does the country have to show for $10 trillion of (over)spending? A sound infrastructure? An educated, productive and motivated workforce? A dynamic and sustainable economy? Cohesive families and societies in this country and outside of it?
It appears that government officials generally have very little ability or desire to improve the fundamentals of this economy. The economic foundations of the real U.S. economy have been so weakened over the past few decades because of poor regulations, a non-consistent legal system, a generally undereducated (perhaps mis-educated) workforce, a deteriorated social structure and a perverse incentive system where people, businesses and governments are rewarded more by poor decision-making than with planning and prudence.
It is quite amazing that in the 21st century, government economic “management” of the economy is essentially reliant upon growing one economic bubble after another. It fueled the dot-com bubble in the 1990s (Fed Chairman Greenspan continued to inflate the bubble more than three years after expressing public concern about the stock market bubble). Similarly, after the dot-com crash, ultra-low interest rates (as well as changes in government mortgage regulation) was used to create a real estate and mortgage bubble that would nearly destroy the world’s economy and did in fact cause economic devastation for millions.
As has become clear since the latest crash, governments don’t really know how to produce economies that bring lasting improvements. During and after the last financial meltdown everyone knew that the extreme debt build-up of household, government and corporations was a primary factor in the pre-crash bubble. The necessary solution would be to reduce debt on every front. That simple solution entailed allowing interest rates to drift higher to market-clearing levels. Instead, interest rates were pushed to the floor (with foreign governments following suit), which had the inevitable consequence of further increasing debt. And debt surely did rise, adding more than $60 trillion in global debt over the following seven years (see chart below). (The trend in global debt accumulation has not changed since the 2014 data in the chart. Reuters recently reported that U.S. corporations issued record debt amounts in 2016, the sixth year of issuance records in a row.)
At this point, the economy is (along with the bubbles that support it) completely dependent upon the continuance of high levels of yearly debt accumulation. That means that they are dependent upon interest rates staying at rock-bottom levels. If interest rates were allowed to rise in any substantial way to a more normal level, record-high levels of debt issuance would become impossible, and these bubbles at every level – corporate, household and government - would pop.
I’ve previously talked (“Normal Debts Will Never Be”) about the consequences to the government debt and spending bubble if interest rates were allowed to rise just a few points. Its high debt levels and basic mathematics dictate that normal interest rates simply can’t happen in the future. Likewise now, with auto loans, student loans and other consumer loans. A large segment of the population is highly indebted, already struggling with their bills and their debts, can’t afford higher interest rates on their debts. Lastly, investors have bid the stock market to by some measures the highest level in history (see hussmanfunds.com).
With consumer confidence tied so closely to the market, the Fed is all too aware of what will happen to confidence (and possible spending) if the stock market takes a tumble. Bond market investors have also enjoyed the bond market bubble and don’t want to see higher interest rates. The slight interest rate increases of the last nine months or so has already caused significant losses for many. There will be serious worldwide consequences if the tens of trillions of dollars of bonds start declining materially due to higher interest rates.
Because of the last two economic and financial collapses, directly associated with the popping of financial bubbles, the Federal Reserve has been very, very cautious about popping the bubbles. In fact, they’ve been so cautious about popping this bubble that they kept rate near 0% for more than seven years. And they are going to keep interest rates near record-low levels for a long time to come, despite the inevitable consequences. They have trained consumers, businesses and governments to expect very low interest rates forever. The irony, which the Fed also understands, is that by keeping rates so low and for so long, an increase in interest rates in the past that would not have been a big deal, is now going to be a very big deal. This understanding has further limited the amount that they have and will raise rates. They are trying to walk a fine line between trying to let some of the air out of the bubbles but not wanting to pop them. But they will continue to err on the side of caution, not wanting to pop their third financial bubble in two decades. The inevitable consequence is that the Everything Bubble will continue to grow, until the day when their plan doesn’t work anymore.