I'm sure readers are familiar with the term "Four Horsemen of the Apocalypse" from the Bible's Book of Revelation. It seems to me that the "end times" for the long-standing bull market in stocks was caused by what could loosely be called "The Four Horsemen".
While not an apocalypse, the stock market is back to where it was in 1997. 1997 was, of course, the year that Alan Greenspan made his now-famous utterances about "irrational exuberance". "Irrational exuberance" sure seems to have been wrung out of the stock market.
Here is some data which should not be taken lightly. On a total return basis, Ibbotson data shows that the S&P 500 has now underperformed long-term Treasury bonds for the last five-year, 10-year and 25-year periods, and by substantial amounts.
In the future, if the long-run expected returns on bonds were expected to be higher than the expected return on equities, capitalism as we know it would grind to a halt. After all, who would buy stocks when they "know" that the returns on bonds is better?
So, who are the "Four Horsemen" that helped kill the bull market? The four culprits are - Wall Street, the Federal Reserve, Washington D.C. and the media.
Congress Gone Wild
Over the past 40 years, Washington - both political parties - has followed a ruinous policy and has progressively transitioned America from a "producer" economy to a "consumer" economy. Instead of accumulating wealth, America is rapidly depleting its wealth.
One way to measure this depletion of wealth is by looking at the long-term value of the US dollar, which affects everyone, not only investors. I believe that the best way to look at the dollar's long-term decline is not by comparing its value to other declining currencies, but versus the value of gold.
Since 2000, the US dollar has depreciated against gold by an average of 16.3% annually. In the past three years, versus gold all holders of US dollars have suffered a 60% erosion of their wealth. That's before taxes and that's not counting any investment losses.
Bankers Gone Wild
Now let's look at Wall Street. The top three Wall Street money center banks have a total of $100 trillion in exposure to derivatives. And that is just the tip of the iceberg as far as problems on Wall Street. Wall Street bankers seem to have lost their collective minds. Why?
A major part of the problems on Wall Street has stemmed from their distorted and perverted incentives system. The capitalist system is all about incentives. People are rewarded handsomely when they take risks and win. But when people take risks and they lose, they should have to pay the penalty.
What we have now in America is something completely different. The incentive system put in place by Wall Street has produced the worst possible economic system. We have capitalism for the profits and socialism for the losses. Heads - Wall Street wins, Tails - taxpayers lose.
Media Gone Wild
Everything connected to Wall Street seems to have become corrupted, including media. CNBC is such an obvious target, with people Larry Kudlow and Jim Cramer, but I wanted to talk about another media company - McGraw-Hill.
A prime example of problems with how the media has covered this financial crisis is the recent controversy surrounding the publication of Barry Ritholtz's book "Bailout Nation: How Easy Money Corrupted Wall Street and Shook the World Economy". Barry Ritholtz, by the way, is the author of a popular finance blog, "The Big Picture".
In 2008, the book was to have been published by McGraw-Hill. But they dropped the book. Why? Ritholtz claims that he butted heads with McGraw-Hill over some passages he wrote about bond-rating agencies. McGraw-Hill happens to own ratings agency Standard & Poor's.
Bond-rating agencies, of course, accepted huge fees from investment banks for rating many types of securitized bonds as "AAA". Many of these securitized instruments contained nothing but garbage in them. However, the AAA-rating allowed Wall Street to sell these securitized instruments all over the world and are a major contributor to current financial markets woes.
According to Newsweek, in his original draft Ritholtz dubbed the acceptance of fees as "payola" and called the ratings agencies "pimps". Apparently, this did not sit well with McGraw-Hill. Why? Because the author was truthful?
The Fed Gone Wild
Finally, there is the Federal Reserve. In an effort to combat the current downturn, Ben Bernacke and the Fed seems intent to compound Alan Greenspan's previous mistakes and has gone full-time into the creation of funny money.
The Fed seems to believe that monetarism can fight a financial crisis caused by excess liquidity and debt by churning out even more liquidity. The Fed seems to be ignoring the fact that the strong growth and low inflation seen for the past two or three decades was simply a credit-driven illusion induced by deficit nations like the US.
The flood of cheap goods from the emerging markets is the main reason that the historical link between the supply of money and inflation has been weak. It seems absolutely absurd to continue to assume that the exponential growth in the monetary base will not eventually produce some very nasty side effects, namely inflation.
Yet, this is what the Fed, Wall Street and Washington wants investors to assume. They want investors to focus on the very short-term deflation and to ignore that in the longer-term, in a fiat money system, deflation simply cannot exist. If investors continue to focus on short-term deflation, they will continue to purchase (foolishly) US Treasuries at near zero per cent interest rates.
Instead of pursuing its current policies, the Federal Reserve and other policy makers should be focusing on trying to create a new paradigm where economic growth is created by something other than a flow of cheap credit. Until that happens, the bear market in stocks looks to continue to linger.
updated Apr 11, 2009
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