How Low Interest Rates have Created a Hidden Inflationary Economy
This is Part 2 of a series of articles regarding the Federal Reserve Board’s recent statement, that they do not understand why inflation remains below 2% as they proclaim a robust economy.
The primary method the Feds use in their attempt to control the economy or the stock market, is to raise or lower the interest rates to the big banks that need to borrow overnight money to meet shortages on obligations. The adjustments to interest rates has been used as an attempt to slow down the Technology Stock Market Bubble but failed. It was also used to attempt to halt the Bear Market that followed that bubble. In lowering interest rates too severely and for too long, the Feds inadvertently funded the Real Estate Bubble of 2003-2007 and provided the monies for the Mortgage Backed Securities debacle and Credit Default Swap fiasco of 2008.
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The problem with this theory that controlling “money flow” via the raising and lowering Fed’s interest rate to big banks, is that the Feds have no control over how the big banks use the money lent.
Inflation is present in our economy. It is not where the Fed’s expected it to be. The Federal Reserve assumed wrongly, that by keeping interest rates low corporations would invest in infrastructure and in creating new jobs between 2009 -2014. Such was not the case.
Corporations used the low interest money and their rising profits due to massive layoffs to Buyback billions of dollars’ worth of their company stock, and reducing the outstanding shares are artificially inflating the stock price.
This benefited the corporations which were eager to create an environment where dividends would rise to satisfy their largest investors, The Dark Pools. It worked. By buying millions of shares of their own company stock, the stock price rose as fewer shares were available. It moved money out of manufacturing, out of infrastructure, and out of payroll increases and into the stock market.
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In essence, the Fed’s attempt to control big business and big banks failed. Companies used the money to artificially inflate EPS by reducing the number of outstanding shares. Nearly every major corporation had Buybacks sometime during those years.
What has happened because of this is inflation in the stock market rather than inflation in wages and consumer products, hence the below 2% inflation in an economy that has been stated as “robust.” Unemployment has fallen to record lows, but wage income is stagnated.
The chart example below shows the Negative Deviation of Fundamentals from stock values. The S&P500 is running up. However the S&P500 companies have had lower earnings and revenues quarter over quarter, since the end of 2016 when a Peak formed in the Earnings and Revenues Cycle.
Most investors are unaware of this fact because they are using Year over Year data, but a contraction of business has been underway throughout 2017. Stock prices are climbing while each quarter, the earnings and revenues are declining. Why can this be hidden? Why doesn’t year over year show this divergence?
Because in 2016 earnings and revenues went negative as shown on the chart. The red line represents earnings and revenues increases and decreases. By using a year over year comparison, comparing 2016 quarter 1 to 2017 quarter 2 makes 2017 seem stronger. But in truth, the earnings and revenues are lower each quarter this year.
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The Federal Reserve Board historical low interest rates are creating a bubble in the stock market. But not just in stocks, in a relatively new trading investment that professionals are concerned will create a sudden collapse. The risk of a new investment like Credit Default Swaps, is that no one can accurately predict the severity of that correction.
Next Week: the new investment that is creating a hidden bubble within stocks.
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Martha Stokes CMT
Chartered Market Technician
Instructor & Developer of TechniTrader Stock & Option Courses
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