April 9, 2013
Monetary and fiscal policies have driven our economy into an unstable equilibrium, pushing investors into higher-yielding securities, according to John Hussman. But those higher yields are illusory, he said, because corporate profit margins are too high to be sustainable.
“This creates an environment where stock returns prospectively are very low,” Hussman said. “In fact, all returns are prospectively very low.”
Hussman is the president and principal shareholder of Maryland-based Hussman Econometrics Advisors, the investment advisory firm that manages the Hussman Funds. He rarely gives interviews and almost never speaks in public, but he spoke at the Wine Country Investment Conference last week. That event was sponsored by Mish Shedlock and his firm, California-based Sitka Pacific Capital Management, as a benefit for ALS, the disease which claimed Shedlock’s wife last year.
Quantitative easing (QE) has distorted market dynamics and pushed investors into riskier assets. “That is really the point of QE,” Hussman said. “It is to create discomfort and cause a search for yield. “
I’ll discuss Hussman’s opinions on monetary policy and corporate profit margins and his forecast for equity returns.
The price we will pay for quantitative easing
The theory behind fractional reserve banking is that increasing the reserves held by banks, which the Federal Reserve does through QE, will result in an expansion of credit and lending. This expansion is thought to be proportional at a ratio of 8-to-1 to the degree to which banks are leveraged. For example, a $1 increase in reserves should result in $8 of banking lending.
The Fed’s aggressive QE measures have increased the capital held in bank reserves. So why hasn’t that led to increased lending?
The problem, Hussman said, is that the theory “assumes away all the economic issues that matter.” Our current economy lacks productive investment opportunities, borrowers who can service new debt and lenders willing to finance productive activities, according to Hussman. Moreover, he said our regulatory environment is not strong enough to prevent lending to unworthy and unproductive speculators.
“It’s as if economic activity just is generated by some change in what we do on the policy front,” he said.
Indeed, as Hussman showed, QE has failed to produce economic growth.
He presented the graph below, which shows the percentage change in the monetary base on the x-axis and the percentage change in monetary velocity on the y-axis, each on a four-year annualized basis. Velocity is a measure of how fast money changes hands in the economy.
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