The US stock market peaked in October 2007 with the Dow reaching a high of close to 14,200. Government guaranteed mortgages and a loose monetary policy by the Federal Reserve fueled the real estate bubble. Artificial low interest rates and excessive credit creation by the quasi-private Central bank lead to much malinvestment and speculation. The appreciation of property values not only made sellers of real estate rich but allowed those that refinanced to live a lifestyle they otherwise couldn’t afford.
Many Americans that had a modest salary enjoyed the financial irresponsible spending that was made possible through home equity loans. Others enjoyed the temporary high salaries that were made possible by the increased consumer spending and those employed within the Real Estate sector benefitted from the high transaction volume.
US equities only traded at their artificial high levels as a direct result of the housing and credit bubble. The increased economic activity allowed for massive consumer spending which resulted in record earnings for companies pushing the Dow Jones Industrial Average and NASDAQ to unsustainable record highs. With the beginning of the Real Estate collapse that started with subprime defaults and by no means was isolated to the lower income demographic the consumer spending came to a quick halt as individuals were limited to a level of spending they could afford.
With banks having been exposed for the nearly insolvent institutions they are, consumer spending limited without easy access to credit, and a significant rise in home loan defaults the DOW reached a low near 6500 in February of 2009. The Federal Reserve and the President’s Working Group on Financial Markets pumped trillions of dollars into the market to prevent a further down trend in equities.
In March 2009 the accounting rules were changed eliminating mark to market accounting rules and replacing it with a “mark to bubble” system that allowed financial institutions to take the previously written down losses and mark them up to a value of their choice. The sudden increase in value was translated to gains and the financial institutions reported record phantom profits since that accounting change. Nobody in their right mind can seriously believe that the financial companies that were on the verge of collapse could turn to record profitability within a few months.
Fundamentally nothing has changed with the U.S. Economy since the Real Estate bubble and the US Economy were exposed for what they are. This recovery has only been made possible through unprecedented market interference and bailouts which include:
- Changes in accounting regulation, eliminating mark to market and implementing the Enron accounting system
- Injection of trillions of dollars of newly created “capital” by the Federal Reserve
- Artificial low short term rates that allows financial institutions to borrow money at nearly free terms in order to trade equities and bonds
- Foreclosure Bailouts and Loan Modifications that allowed many Americans to live mortgage and rent free for several years
- Avoiding foreclosure allows the banks to keep their non-performing loans on their balance sheets without having to realize those losses. The hidden losses remain artificially marked up on the balance sheets while contributing to the profitability of the institution’s quarterly statement.
With a majority of Americans free of mortgage obligations for several years the US Economy appeared to have recovered as sales of consumer goods rapidly increased. Many stocks are trading higher now than they did at the peak of the Real Estate bubble in 2006. Given that fundamentally the US Economy is fueled by similar unsustainable variables that allow Americans to continue living beyond their means it is naïve to expect a continuation of this bull market.
Many companies reduced their American workforce in response to the market decline in 2006 through 2009. Since consumer spending returned to bubble levels they are more profitable now than in the past as they book similar or greater revenue with fewer overhead costs. While a reduction in workforce was a viable option for companies to address the slowing economy and deal with unprofitability, WTF Finance warns that US companies will no longer have that option in the upcoming downturn.
WTF Finance especially warns foreign investors as they not only are exposed to the equities that benefitted from the re-inflation of the bubble but also the value of the US Dollar. As we’ve reported in our article “Geithner Criticizes China” the biggest foreign holder of US Treasuries is becoming increasingly concerned about its US currency holdings as they are rightfully worried about future inflation and the potential default of the United States. WTF Finance shared the “Historic Lessons Of Inflation” and also explained why official CPI data is not a true reflection of inflation in our past articles.
WTF Finance does not suggest to panic sell into market weakness but does recommend selling equities that primarily depend on the true economic health of the American consumer. A rebound of US equities could be a last chance to cash out of your positions before the unsustainable fake US Economy is exposed for what it is.