"Our goal is to make finance the servant, not the master, of the real economy."
- Alistair Darling
The traditional tools that the Federal Reserve uses to accomplish that "wealth effect" objective include stock market, interest rate and currency intervention, and in more recent years, "quantitative easing", more informally known as money-printing. In recent years this has been a favored tool to keep the stock market levitated. Fed money-printing over the past five years has resulted in a balance sheet that has been inflated by over $3 trillion. Much of that new money has gone directly into the stock market.
With five years of such interventions, stock market traders have dutifully lifted the market to record levels. Over those past five years, the U.S. stock market has done quite nicely (using the popular S&P 500 index as a proxy), nearly tripling from market lows in 2009, including an increase of more than 30% in 2013. In fact, the stock market, judging by conventional metrics, is now in rarified and "bubbly" territory, with the stock market as a whole trading at about 17 times hoped-for (and Fed-enhanced) 2014 earnings. For the past four decades, a higher valuation has only been seen about 2% of the time. A chart http://www.multpl.com/shiller-pe/ by influential economist Robert Schiller indicates that the price-earnings ratio based on average earnings for the prior 10 years is currently around 25, about 50% higher than its average level and higher than nearly all stock market peaks for the past 130 years, except for the stock market bubble of the late 1920s and the one ending in the year 2000. Other areas of the stock market appear even more overvalued. The small-cap sector of the stock market, as measured by the Russell 2000, is currently trading at an average price-to-earnings ratio of about 80 times. And last but not least, the average Nasdaq stock trades at a PE ratio of about 35. With such remarkable increases in the stock market, the "wealth effect" that is so much desired by policy agents should be in full view, accompanied by a booming economy that is trickling down to benefit those not just at the top, but the less well-off.
Unfortunately for regulators, a $16 trillion economy with 315 million participants is not so easily managed. When we see a government report on economic growth for the entire U.S. economy (which it should be acknowledged, is impossible to accurately know) we have to remember that a country's economic growth is an average. Economic changes don't affect all parties equally. Some will benefit to a greater or lesser degree, while others will suffer. Because of this, a broad economic gauge, such as Gross Domestic Product (GDP), often used as a general measure for how well people are doing, can obscure the economic difficulties facing large sectors of a human population, or even, perhaps oddly, the majority of that population.
It seems logical that those that own the most stock will benefit the most in a booming stock market and those who don't own much or any stock might not benefit. And there are a lot of people in the U.S. who don't own any stocks. A recent Gallup poll asked Americans whether they or their spouse owned individual stocks, stock mutual funds or stocks in a 401(k) or IRA. Just a little over half (54%) of those asked answered that they owned stock investments. This level was down from two-thirds (67%) in 2002.
In addition, despite five years of climbing stock markets, surveys by Gallup show that the average American is rather pessimistic regarding current economic conditions and those expected for the near future. Gallup's Economic Confidence Index measures the extent that Americans believe economic conditions are good, as well as whether or not they believe the economy is getting better or worse. This index has been negative for all of the past five years, with a high of -3 in May of 2013, and with a current reading of about -15. Interestingly, this index has generally been below year-ago levels despite the sharp stock market gains over the last year.
As to the satisfaction of Americans on a more general level, the population does not appear to be in the best of spirits. The chart below reflects Americans' response to the question, "In general, are you satisfied or dissatisfied with the way things are going in the United States at this time." This chart shows the general deterioration in Americans' attitudes over the past 17 years, beginning in 1997. In particular, during the period from 2002 until 2008 the percentage of Americans professing to be "satisfied" with how things were going in the U.S. steadily declined. Although people are generally more positive now than at the depths of the financial crisis in 2008 and 2009, for the past five years, the percentage of those declaring themselves satisfied with the country's direction has generally remained at levels in the range of 20%-30%, with the number of "dissatisfied" Americans often three times the number of those satisfied.
I recognize that Americans' overall satisfaction of the country is based on more than family finances, although traditionally that employs a key part of an individual's satisfaction. Other factors in recent years that may be weighing heavily on Americans' moods might include an increasingly militarized police state, a system of arbitrary law, and revelations of government spying on those within and outside of U.S. borders.
So while markets may be booming much of that is lost on the average American, many of whom are still struggling financially. The percentage of Americans in the labor force is now the lowest it has been in forty years, the federal debt has ballooned more than $7 trillion since 2008 (to over $17 trillion), while the number of Americans on food stamps now exceeds a record 45 million.
The U.S. is a divided country, geographically, politically, socially and economically, often facilitated by governments and media. Financially, it is a nation of haves and have-nots. According to Federal Reserve data (from 2010), 95% of the financial wealth in the U.S. is owned by the wealthiest 20% of Americans. Put another way, the lowest 80% of Americans own less than 5% of the financial wealth in America. The richest 1% of Americans owns more than eight times the wealth of the lowest 80% of Americans.
And as to the argument that a booming stock market is beneficial to that large pool of small investors, the evidence isn't so clear. The majority of small investors are just that – small – many with modest levels of financial assets – often less than $10,000 or $20,000 - and most of that generally targeted for retirement. For those investing at today's high prices and retiring in 5 or 10 years it remains to be seen whether or not future market gains will provide the necessary returns those investors are looking for. In addition, every market bubble creates a market bust, and every bust leads to disgruntled investors who leave for the sidelines and often stay there for years or even decades, often to the detriment of their long-term financial health. A recent Gallup poll found that despite the heady market gains of recent years, just 46% of those surveyed thought investing $1,000 in the stock market was "a good idea". That percentage was down from a level of two-thirds (67%) that existed in the year 2000, at a time when the stock market was routinely making record highs, as it has been in recent months. The market declines of 2000-2002 and 2007-2009 left many investors shell-shocked and yearning for safer places to put their money. Market volatility and government-orchestrated booms and busts simply leads to a more speculative and unapproachable market for millions of would-be long-term investors.
The latest economic "recovery", to use that term loosely, has been fairly non-existent for a large percentage of Americans, perhaps the majority of Americans, but quite good for the richest Americans. The rich have gotten richer while more than half the country lives in a state of financial vulnerability, with general pessimism about the direction of the country and increasingly envious of the wealthy in an economy that favors the politically connected and those with the most financial assets.
I don't doubt that the artificial gains in the stock market has some positive effect on the economy, as the rich are able to spend some of those gains and some of it trickles through the economy. My concern is when the inevitable market correction happens, whether the less fortunate half of Americans will be able to prosper in an economy based on the fundamentals of saving and production and less on cheap and printed money. A market correction, or worse, a stock market crash, may result in a difficult transition from an artificial economy to one with a better foundation.