I believe 2013 was a "fakeout" year. By this I mean that 2013 was a year where, on the surface, there was renewed optimism though I suspect the optimism will be fleeting.
In order to reflect on 2013, I try to see what is on the minds of others. One tool I use is the online dictionary for Merriam Webster. Merriam Webster selects a Word of the Year (WOTY) as suggested by searches on the online dictionary. On a macro level, the internet is a wonderful tool to assess social mood whether from search engines like Google, online dictionaries, or Twitter. Before we look at the 2013 WOTY, let's look at popularly-searched words on Merriam Webster from prior years.
- 2008 - "bailout"
- 2009 - "admonish"
- 2010 - "austerity"
- 2011 - "pragmatic"
- 2012 - "socialism" and "capitalism" (also popular - "bigot" and "schadenfreude")
I used 2008 as the starting point since that was the first year after the stock market top and a marker for the financial crisis. Notice a pattern in the words? There is a definite trend towards conservatism and disharmony. This is to be expected given the financial shock of 2007-2008. Though the stock market bottomed in early 2009, the mood, at least based on word search, still trended in a bearish direction. This brings me to the WOTY in 2013, which is......."science". Other popular search words in the online dictionary for 2013 included "cognitive", "rapport", and "communication". The 2013 WOTY for the Oxford dictionary was "selfie" and for 2012 included "GIF" (Graphic Interchange Format) and "hash tag". Notice a change in the words searched?
Now instead of a focus on conservatism and disharmony there was an increased focus on tech terms. In addition, "rapport" and "communication" reveal a trend change away from disharmony. Once again, I am not surprised by this trend change especially if one subscribes to utilizing the U.S. stock market as a barometer for social mood. The rally in the market this year, particularly near the end of the year, has suddenly made bulls out of bears and is opening the floodgates for stock investors formerly on the sidelines.
Just how optimistic are stock investors now? Margin debt at stock brokerage firms is up to $400 billion. This is real optimism since investors are using borrowed funds to invest. Only 14% of stock market advisory firms are bearish, which is a lower reading than at the 2000 and 2007 tops. These advisory firms, in essence, are the most bullish since the stock market crash of 1987. There is also record low investment in money market funds. This means investors are "all in". There are 10 times the number of dollars invested in leveraged bull funds vs. leveraged bear funds at Rydex. This means that not only are investors "all in" but they are leveraged too.
The stock market itself, while looking quite bullish has seen diminished momentum. The rise of the last couple of weeks occurred with very weak volume as well. The Fed Wizards, whose original charter was to stabilize the banking system, are now in the latter stages of mission creep. The great Wizards feel it is their duty to levitate the stock market and control unemployment. This was never the intention for the Fed.
A subplot to the recent stock optimism can also be found within Bitcoin. I mentioned Bitcoin in my book, but referenced it within the context of an alternative currency that could impact the demand for currency and credit. Bitcoin, however, has now morphed into an investment. After starting at less than $0.50 in 2010, Bitcoin reached over $1,200 in 2013. In December 2013 alone, it reached the $1,200 high and dropped intraday below $500 on the Mt. Gox exchange. Bitcoin's trading volumes increase on down days while volume is weaker during its upward trends. The curious aspect of Bitcoin is that its express purpose is to create an alternative medium of transaction that cannot be altered by a central authority. The reality is a commodity that is experiencing a bubble using the same dreaded medium (fiat currency) that it seeks to circumvent!
I use my own relatives to determine the end of trends. Historically, once the general public is "all in" to a trend, the end of the bubble is near. My relatives are thus a proxy for the general public. This happened in 1999 when a relative urged me to jump into tech stocks. It also happened in 2005 when another relative wanted an old refrigerator and oven for his landlord adventure. Most recently, a relative was patting themselves on the back for their Bitcoin "investment". There are other challenges for Bitcoin acceptance including governments with a need to control that which ultimately gives them their power. Increasingly authoritarian governments will not cede currency control without a great fight (see China most recently). It will also be difficult to transact in a currency whose value fluctuates wildly. Finally, there are a number of new, copycat electronic currencies that have surfaced. Electronic currencies will have their day, but right now Bitcoin is in the throes of a bubble.
Gold continued to fall this year in line with my forecast for deflationary conditions ahead. Gold lost 30% this year. Ouch! This does not invalidate gold as a representation of real money. Commodity prices in general continue their trend down from their highs in 2011.
I frequently mention the withdrawal of government from the economy as another harbinger of deflation. The withdrawal will be seen via the liquidation of debt and the reduction of debt accumulation. Debt liquidation can occur via repayment (deflationary) or bankruptcy (deflationary). Ask Detroit pensioners if they see reduced spending in their future. The U.S. government started their withdrawal from the economy through the reduction of the federal deficit. For fiscal 2013, the deficit is estimated at $700 billion, about half of what it was 2 years earlier. Much of this is attributed to tax receipts (so it is not a withdrawal in this sense) though some is attributable to actual withdrawal in the form of the sequester (budget cuts). I would not anticipate a further increase in tax receipts. The budget battle ahead will pit the forces of politics and economics and I fully anticipate there will be no long-term solutions to increasing health care and pension demands at the federal level. This is not conjecture but merely a generational analysis depicting a baby boom moving through their next phase of life.
The Fed felt confident enough to announce a tapering of their purchases by $10 billion per month. How did the Wizards arrive at this reduction? For months, the markets feared an end to Fed purchases and when they finally announced their taper, the markets saw this as evidence that all was well in Oz. Despite all this Fed action, interest rates on 10 and 30-year Treasury debt continued their increase after pausing a bit this fall. I see this as a capitulation by the market that the Wizards have lost their control on interest rates. This is why they have gone from the "irrational exuberance" comments to open commentary on supporting the stock market. The stock market is their last stand.
Housing appears brighter in some cities but its foundation is speculative. Private investors and hedge funds are buying large tracts of real estate. Is this bad? On the surface, the purchases have provided a floor in real estate and in many cases a renewed sense of optimism. But these purchases are not by those that will actually occupy the dwelling. These investors are looking for yield, like everyone else, and are not "sticky" like an actual occupant would be. There are fewer people under water on their mortgages but millions still cannot see the surface. The Case-Shiller 20 city index went up this year but remains well below its 2006 high.
On the investment front, the Fed actions of buying assets and manipulating rates to near zero have done two things. First, there is absolutely little factual basis for the price of many assets. Fed actions have distorted price mechanisms to the point where it is difficult to assess what true values really are. Secondly, the Fed has absolutely destroyed the fortunes, both literally and figuratively, of savers. Those on fixed incomes have seen their livelihoods utterly dismantled. The days of earning 5-6% on a longer term certificate of deposit are a small dot in the rear view mirror. The secondary effect of this interest rate destruction is the search for yield in increasingly riskier assets.
Yes 2013 was a mirage. Some things look rosier as a result of the Wizards. That rose garden, however, is only financially evident for some (i.e.) Wall Street. For Main Street U.S.A., whatever shoots of optimism existed last year will be ephemeral as we progress through 2014.
Jim Mosquera is the author of Escaping Oz: Protecting your wealth during the financial crisis.