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Mr. Market Wakes Up to the Jobs and Wages Problem

August 10, 2011 | About:
The credit downgrade and debt ceiling aftermath highlight a much more serious problem — a jobs and wages problem — that Mr. Market is finally waking up to.

It's been a violent week on both sides of the Atlantic.

In the United Kingdom, rioters are looting shops and causing mayhem. The worst is in London, but it has since spread to five major UK cities. Two Croydon women, who had been drinking all night, told a BBC reporter it was about showing police and "the rich" that "we can do what we want."

On the finance side, violence has come in the form of cratering markets.

As of Monday night's close, Bloomberg reported, global equity markets had seen $7.8 trillion worth of wealth evaporate in just two weeks. Monday's carnage counted as the sixth-largest point drop in Dow Jones history, the fifth most oversold close ever for the S&P 500, and the worst five-day return since 2008 (via Bespoke Investment Group). At one point in the mini-meltdown, all 500 stocks in the S&P 500 were red. The index itself retreated not just to pre-QE2 levels, but to 1998 levels.

For anyone passively invested via S&P 500 index funds, that's 13 years of churning down the drain — a result much worse than zero when inflation is taken into account.

Where we go next depends on how the Federal Reserve's next moves are received (still unknown as this note goes to press). Risk of a "false rally" is high, be it one that lasts days to weeks, before testing out new lows.

(Now you see why we've been so relentlessly bearish in these pages. It wasn't just for kicks.)

The market may hold out hope for a third round of quantitative easing, aka QE3, or some form of "extraordinary measures." But it isn't clear what the Fed can do to actually help the economy. There are ways they can help the stock market, of course, but that isn't the same thing.

All along, the fiction has been that rising corporate profits would translate to rising economic growth. The trouble is, there are many ways to get corporate profits up without actually helping the economy:

· You can keep the dollar weak, which increases corporate profit margins for goods sold overseas.

· You can lay off millions of employees, and move large amounts of work offshore.

· You can increase overseas revenues, and hide the profits in offshore tax shelters.

· You can focus on the top 30% or even the top 10% of consumers, ignoring the bottom 70-90%.

Large corporations have done all the above, while enjoying rock-bottom borrowing rates in the highly liquid corporate bond market, even as small businesses have been left out in the cold.

At the same time, monetary policy has been aimed at helping large banks and well-financed corporations. As we have pointed out repeatedly, though, there have been no meaningful changes in the "real" economy. The gap between "Wall Street" and "Main Street" finally grew too wide to ignore.

The stomach-churning stock market drop was blamed on the awful timing of the U.S. credit rating downgrade, coming as it did against a debt ceiling showdown, a backdrop of worsening economic data, and fresh crisis threats in Europe.

Truthfully, though, it is mostly the same old stuff coming back to light. Other than "pile on lots of stimulus," there was never an actual plan for getting things on track.

And there still isn't. Those who urge the Federal Reserve to "do something" cannot say with any clarity what exactly it is that they should do.

Some believe a new recession is already here. As John Hussman wrote to investors in his weekly commentary,

The economic evidence now suggests that the U.S. and the global economy are again entering recession. Technically, this is not a "double dip." The National Bureau of Economic Research, which officially dates the beginning and end of U.S. recessions, was very clear about this last year -- noting that it would view any future economic downturn as a new recession, not as a continuation of the one that ended in June 2009.

If there is one crucial point that should not be missed, it is this: the fundamental source of our economic challenges, from joblessness, to unresolved housing strains, to sovereign debt crises, is that our policy makers have repeatedly opted for fiscal band-aids and monetary distortions instead of addressing the core problem head-on. That core problem is simple: the careless encouragement of asset bubbles, and the refusal to restructure bad debt.

Jobs and wages are where the real pain hits. The jobs just aren't there, and wages are stagnating.

One tried-and-true way for an indebted country to get fiscally healthy again is through a rising job market, with rising wages to offset the weight of household debts. A better jobs picture also makes it easier to work off government debts, as higher revenues come in at state and federal levels.

We don't see that this time, though, because corporate profits have come at the expense of households. The jobs aren't there; the wages are flat. In addition, small businesses — the traditional engines of new job creation — are out in the cold. Mr. Market is waking up to these issues.

From a trading and investing standpoint, it is becoming increasingly likely the central banks will "do something" about this problem. If their increasingly desperate efforts fail — as they have so far — they will eventually be forced to go "nuclear," Europe and Japan as much so as the United States.

This means at least two things: One, that the outlook for precious metals remains very bright; and two, that companies with strong earnings and "pricing power" — especially in the face of recession and central-bank-induced inflation — could be excellent values when the latest round of bloodletting is done.

It's a good time to keep one's powder dry.

Written by Justice Litle for Taipan Publishing Group. Additional valuable content can be syndicated via our RSS feed. Check us out at www.facebook.com/TaipanGroup. Republish without charge. Required: Author attribution, links back to original content or www.taipanpublishinggroup.com.

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