Here is my latest article and
presentation (click here to open PDF)
of the 'steroidization' of our economy. The presentation
covers the main concepts discussed in the article and also shows
how we are positioning for this very different economy.
Birds are singing, the sun is shining and life is beautiful
again. On the surface, the vital signs of our economy are improving
with every economic report. In some areas, like unemployment, the
rate of decline is decelerating; in others, like GDP, decline is
turning into growth. The stock market is behaving as if the history
of the last twenty years is about to repeat itself: recession will
turn into a robust expansion. Stock prices are discounting an
expectation of robust earnings recovery to a level only slightly
below the pre-financial crisis level, and risk taking is in vogue
again as the performance of junky stocks trumps quality.
The global economy reminds me of a marathon runner who runs too
hard and hurts himself. But now he has another race to run. So he's
injected with some serious, industrial-quality steroids, and away
he goes. As the steroids kick in, his pace accelerates, as if the
injury never happened. He's up and running, so he must be ok; this
is the impression we get, judging from his speed and his
What we don't see is what is behind this athlete's terrific
performance - the steroids.
Of course, we can keep our fingers crossed and hope that the
runner has recovered from his injury and what we see is what we get
- the athlete is at the top of his game - but there are problems
with this thinking. Serious steroid intake comes at a cost: it
exaggerates true performance. Steroids can be addictive; once we
get used to their effects it is hard to give them up. The longer we
take them the less effective they are. Finally, there is a good
reason why steroids are banned in sports: they damage the athlete's
Our economy suffered severe injuries last year, and to keep it
going massive amounts of steroids were and are being injected -
they're what economists call stimulus (or government
Let's take a closer look at the extent of the 'steroidization'
(to coin a new word) of our economy, and its side effects.
I'll focus on the US economy, but similar arguments to varying
degrees are true for many countries around the world. In the US,
things appear to be stabilizing and improving on the surface, but
beware: there is a giant IV hooked up to the veins of the economy,
through which billions of dollars are constantly being pumped in.
The stimulus is everywhere:
- To help the auto industry taxpayers were subsidizing the
price of autos through the "cash for clunkers" program and thus
were creating artificial demand.
- The housing market, the epicenter of this crisis, is propped
up from different directions. On one side there is a buyer (it
used to be the just first-time buyer, now it is any buyer) tax
credit. From a different direction interest rates are kept low by
the Fed's quantitative easing, fancy econ-speak for the Federal
Reserve buying long-term bonds and thus keeping long-term rates
artificially low. Finally we have the (now) defunct
government-controlled Fannie (
) and Freddie (
), which are the mortgage market of our economy, since they
account for the bulk of mortgages originated today.
- Since banks are the conduits through which the government
pumps stimulus into the economy, the aforementioned government
involvement in the housing market helps them generate enormous
fees. In addition, profitability is boosted (at the expense of
savers) by the near zero short-term interest rates, again thanks
to the friendly Fed, that allows banks to earn a healthy
- Last, and certainly not least, the giant,
multi-hundred-billion-dollar infrastructure projects are coming
online as you read this. Yes, 'steroided' we are.
Now let's look at the side effects:
- Our economy's true, unsteroided, unstimulated performance is
a lot lower than the one we observe. Though the government can
spend money at a high rate for longer than one would rationally
expect, stimulus is a finite endeavor that comes with a heavy
price tag. In most cases the stimuli have been financed with
higher future taxes and rising government debt, thus higher
future interest rates.
- Steroids and stimulus share addictive properties, and the
longer we take them the less effective they become; but once
we're used to them it's hard to give them up. The $8,000 tax
credit started as a temporary measure. However, the politicians
found it difficult to let go, and the program was extended and
supersized by providing the tax credit to anyone with the
patriotic ambition to buy a house.
- Japan was on the stimulus bandwagon for more than a decade
and, with the exception of its government debt-to-GDP ratio
tripling, Japan has nothing to show for it. Their economy is
mired in the same rut it was in when its stimulus marathon
started. It had a hard time giving up stimulus because the
short-term consequences were too painful. Also, Japan is proof
that a low (zero) interest-rate policy loses its stimulating
ability over time and turns into a death trap for the economy as
leverage ratios are geared to low interest rates. Now, even a
small increase in interest rates (say, from 1% to 2%) would be
devastating for Japan's economy.
- In many cases the simulative measures just accelerate future
sales to an earlier date, at the taxpayer's expense. After "cash
for clunkers" ran its course, demand for autos fell into the
abyss. The same will be the fate of industries exposed to
- Finally, stimuli result in long-term damage. Politicians and
central bankers have good intentions; they hope that the stimulus
will tide us over the bad times and buy some time for the economy
to heal itself. It's a logical argument. For instance, as much as
we hate banks to be making a lot of money today, it allows them
to patch up holes in their balance sheets from past and future
losses. However, for the most part stimuli just kick the can down
the road and result in higher debt and higher taxes. But the harm
doesn't stop there: stimuli cause bubbles. The fix for the 2002
recession involved interest rates staying at extremely low levels
for a long time, which resulted in the housing/liquidity bubbles
we're paying for today. The present stimuli will leave us with
even more serious damage somewhere down the line.
The stock market's recent rally followed a typical, by-the-book,
coming out of recession trajectory - it was cyclical. The stocks
most sensitive to the economy appreciating the most.
Let me demonstrate what is priced into cyclical stocks by
looking at Caterpillar (
) - your typical American blue chip industrial, cyclical stock -
one that, in theory, should prosper during global economic
Third-quarter sales were down 44% from last year. China was its
brightest spot as sales there dropped (only) 26%. The stock is
around $60, more than double its low in March and not far from $85,
its all-time high, reached in 2008 when global growth was its
oyster. The company expects to earn around $2 this year (excluding
recurring nonrecurring charges) and expects sales to grow in teens
next year from this year's base. But even if CAT were to earn $3
next year, investors are not paying for next year's earnings, as
they'd paying 20 times next year's earnings.
This cyclical stock is not worth that; investors are paying for
what happens beyond 2010.
To understand what happens past 2010, let's see what is driving
CAT's next year's earnings growth. Here is a quote directly from a
CAT press release: "[Global] Governments introduced more than $3.5
trillion in multi-year stimulus programs with most of the expected
impact in the last half of 2009 and into 2010."
If I owned CAT, the question I'd want to know the answer to is,
what's next after 2010?
Stimulus creates an appearance of stability and growth, but a
lot of it is teetering on a very weak foundation of government
intervention. Investors must distinguish between what is real and
what is not; in this environment, investment success will not only
depend on what stocks you own but also on the ones you don't -
stock selection is important.
The hopes that we'll transition soon from government steroiding
back to an economy running on its own are overoptimistic; there is
just too much stimulus in the economy for that to happen. The detox
process from the massive consumption of steroids will not be a
smooth and painless experience.
This transition will be slow and rocky, as today's stimulus
wears off and we hit the wall in this economic marathon.
P.S. The four most dangerous words on Wall Street: "This time
it's different." However, this time, this recession, is not the
same, either; we are not suffering through your garden-variety
corporate recession, it's a consumer one. Consumers, two-thirds of
the economy and its past growth engine, are now the economy's
weakest link: consumer debt-to-GDP is pushing 120%, double what it
was in the 1980s. The financial system, though stabilizing, is
hanging on the whims of one economic statistic: employment.
Over the last couple of weeks we have started seeing the first
signs of a second (or third, I'm losing count) wave of layoffs. For
instance, J&J (
), Electronic Arts (
), and Pfizer (
) all announced they'll lay off a large percentage of their
workforce. Higher unemployment will trigger larger loan defaults,
and then we may even have another round of bank problems.
John Tamny on the U.S. Dollar and Economy