News Source:lombardiletterauthor: John Whitefoot, BA
Will a U.S. Economic Collapse Happen in 2017?
Could the U.S. experience an economic collapse in 2017? The idea sounds pretty implausible; after all, U.S. stocks are at record levels, unemployment has fallen to 4.6%, and the Fed recently raised its key lending rate. Surely these are signs that the U.S. economy is going strong?
The economic forecast for 2017 is more than bleak, and there is more than enough economic data out there to show there could be a U.S. economic collapse in 2017. Despite trillions of dollars in quantitative easing, the U.S. economy remains fragile, and not even the euphoria, hype, and optimism around President-elect Donald J. Trump will be able to resuscitate what President Obama left him.
#1. U.S. Unemployment Is Not 4.6%
There has been a lot of hype about how the unemployment rate has improved over the last number of years, from around 10% in early 2010 to 4.6% in November 2016. And frankly, halving the unemployment rate to just 4.6% is pretty incredible. Unfortunately, it isn’t really true. Or rather, it is if you don’t look at all the data provided by the Bureau of Labor Statistics (BLS). (Source: “Employment Situation November 2016,” Bureau of Labor Statistics, December 2, 2016.)
Consider the November jobs report. According to the BLS, the unemployment rate fell to 4.6% and 178,000 new jobs were created. On the surface, this sounds amazing, and perhaps President Obama deserves another Nobel Prize. But it isn’t and he doesn’t.
The unemployment rate does not include discouraged workers who cannot find jobs and have stopped looking. And those jobs that were created are not what they appear either.
First, let’s look at the actual unemployment rate. The improved jobs data comes as a result of new jobs (more on that later) and partly due to those retiring or leaving the workforce.
The unemployment rate is down so much because the number of Americans not in the workforce soared by 446,000 in November to a record 95.1 million. The participation rate hit 63% in March and has been struggling since then. In November, it was 62.7%, a little shy of the October 2015 all-time low of 62.4%. Add it up and the overall underemployment rate is 9.3%.
What about the jobs being created? Of the 178,000 jobs created in November, only 9,000 are considered to be full-time jobs (defined as 35 hours or more per week). The rest are part-time, and most of those are low paying. The demand for waiters and waitresses remains strong, with food services and drinking places adding 19,000 jobs. U.S. unemployment may be low, but it isn’t because the U.S. economy is strong and creating secure, well-paying, skilled jobs.
Wage growth is down and the demand for low-paying, part-time jobs is up! An economic recovery and strong jobs growth? Not yet.
#2. U.S. Inflation Is Stretching American Households
Another reason to fear a U.S. economic collapse is inflation. In November, consumer prices rose for the fourth consecutive month and the consumer price index, which measures what Americans pay for everything, increased a seasonally adjusted 0.2% month-over-month. Prices climbed for gas, rent, and used cars, but declined for groceries and clothing. (Source: “Consumer Price Index,” Bureau of Labor Statistics, December 15, 2016.)
On a year-over-year basis, overall prices were up 1.7% in November, the strongest annual gain since October 2014. The upbeat data no doubt gave the Fed the encouragement it needed to raise rates for just the second time in a decade in December.
Against a backdrop of weak jobs creation and wage growth, 1.7% inflation doesn’t sound like that big of a deal. But it is, because 1.7% isn’t the real inflation rate. To get a feel for what Americans are really paying, it’s a good idea to consider the Chapwood Index.
The Chapwood Index is an alternative non-government measure that looks at the unadjusted costs and price fluctuations of the top 500 items we buy (insurance, gas, coffee, dry cleaning, movie tickets, etc.) in the 50 largest cities in the U.S. Thanks to the Chapwood Index, you can see what people around the U.S. pay for the same products and track the change in living costs. (Source: “Welcome To Chapwood Index,” Chapwood Index, last accessed January 3, 2017.)
For example, in New York, Los Angeles, Chicago, Philadelphia, San Diego, San Jose, San Francisco, Seattle, Boston, and Detroit, the five-year average for inflation is over 10%.
Even if you lived in Colorado Springs or Wichita, the cities with the lowest inflation rate, where the five-year average for inflation is around 7.5%, your cost of living is still significantly higher than the official rates.
No matter where you live in America, inflation is seriously outpacing what you make–and, chances are, putting more and more Americans in debt.
#3. More and More Americans in Debt and Out of Money
Seven years into the so-called U.S. economic recovery, prices are up and Americans are making less, are in debt, and have little set aside for an emergency. For an economy that gets more than 70% of its GDP from consumer spending, this is not a recipe for economic success.
Case in point: over the last decade, U.S. household debt has soared 11% with the average household owing $132,529. (Source: “Household Debt Nears Pre-Recession Levels,” NASDAQ.com, January 4, 2017.)
Total U.S. consumer debt in 2016 is expected to ring in at $12.5 trillion. This would trump the total debt of $12.37 trillion in December 2007, when the Great Recession started.
It’s getting harder and harder to pay that debt off too, even according to official data. Over the last 13 years, the cost of living has increased 30%, but household income is up 28%. The most expensive debt, credit cards, costs the typical household $1,292 annually in interest charges. With interest rates expected to rise three times in 2017, that debt burden is going to get even worse.
The debt burden has put a strain on American households. Almost half of all Americans (47%) would have to borrow money if they had an emergency expense of just $400.00. Is it any surprise close to 46-million Americans receive food stamps? (Source: “66 million Americans have no emergency savings,” CNBC, June 21, 2016.)
#4. U.S. Economy Not Prepared for Rate Hikes
More and more Americans are relying on part-time jobs, which pay poorly, and getting themselves further in debt. And the Federal Reserve is adding some fuel to fire in the form of rate hikes.
After years of artificially low interest rates, the Federal Reserve is starting to raise rates. While it’s high time the Fed raised rates. It waited too long, and the repercussions will create another U.S. economic crisis.
Low rates were designed, in principle, to help kick-start the economy. Banks offer cheap money, Americans borrow and spend, and voila, the U.S. economy is on fire once again! The low interest rates were great news for those with a mortgage, loan, or credit card, but in a low-growth environment, that interest rate hike could cripple the U.S. economy.
In December 2015, the Fed raised its key lending rate for the first time in a decade. It was a small hike, but it showed consumers how even a small increase affects mortgages, car loans, savings rates, and other forms of interest-sensitive credit.
In December 2016, the Fed raised rates again, by a quarter of a percentage point, to a range of between 0.5% and 0.75%. Federal Chair Janet Yellen said the economy has proven to be remarkably resilient and that the hike is a vote of confidence in the economy. (Source: “FOMC Minutes,” Federal Reserve, December 14, 2016.)
But is the U.S. really strong enough to withstand another rate hike? The U.S. economy continues to face a lot of headwinds, including weak global economic conditions, high household debt, and a lack of well-paying jobs.
The U.S. economic outlook is somewhat muted as well. In a best-case scenario, the Fed believes the U.S. economy advanced 1.9% in 2016 and will advance 2.1% in 2017. Assuming the U.S. economy grows as anticipated, the Fed will raise rates three times in 2017, ending the year with a rate of 1.4%.
Again, that’s assuming President-elect Donald J. Trump’s economic action plans will send the U.S. economy into overdrive. No matter how admirable, Trump’s plan to cut taxes and increase spending, when the national debt is already at $20.0 trillion, will be hard to achieve.
Weak economic growth, coupled with rising interest rates, could cobble the U.S. economy and send it back into a recession.
#5. U.S. Stocks Significantly Overvalued
U.S. benchmarks are trading at record levels and Wall Street couldn’t be happier. After a terrible start to 2016, equities rebounded with the S&P 500, finishing the year up nearly 10%. The Dow Jones Industrial Average soared 13.5% in 2016, while the Russell 2000 Small Cap Index was up 20% in 2016.
The long-in-the-tooth bull market is about to enter its ninth year and analysts remain adamant that the bull market, the second-oldest in history, could go on and on for years.
Sadly, the bull market isn’t based on once-tried-and-true fundamentals like earnings and revenue growth. The current bull market was born on frustration. The Federal Reserve took “income” out of fixed income investments when it introduced its first round of quantitative easing and gutted interest rates.
Four rounds of quantitative easing and artificially low interest rates may have helped those with money make even more money, but it decimated the retirement plans of those who relied on fixed-income investments like certificates of deposit, bonds, and Treasuries to provide them with steady income and help them through retirement.
But with returns hovering near zero, the only place left for investors to park their retirement money was in the stock market. Over the last nine years, investors have sent stocks higher and higher, despite weak earnings and revenue growth. On the surface, that’s good news for those with their money in stocks. But it’s also pushed valuations into nosebleed territory. And should the U.S. experience an economic crisis in 2017, you can expect stocks to hit a brick wall and crash.
How far will U.S. equities fall?
According to the Case-Schiller CAPE/PE Ratio, the S&P 500 is overvalued by 73%. The ratio is based on average inflation-adjusted earnings from the previous 10 years. The 100-year median is around 16. The ratio is currently at 27.80; this means is that for every $1.00 of earnings a company makes, investors are willing to fork out $27.80. The ratio has only been higher twice, in 1929 and 1998/99. (Source: “Online Data Robert Shiller,” Yale University, last accessed January 4, 2017.)
Another economic indicator also suggests U.S. stocks are significantly overvalued. The market-cap-to-GDP ratio, which compares the total price of all publicly traded companies to GDP, is also called the “Warren Buffett Indicator,” since the “Oracle of Omaha” calls it the single best measure of valuations.
A reading of 100% suggests U.S. stocks are fairly valued. The higher the ratio is over 100%, the more overvalued the stock market. The market-cap-to-GDP ratio is currently at 126.9%. The Warren Buffett Indicator has only been higher twice since 1950. In 1999, it came in at 153.6%, and in late 2015, it was at 129.7%. It was only at 108% before the 2008 financial crisis.
Over the long run, stock returns are determined by interest rates, corporate profitability, and valuations. Interest rates have an inverse relationship to stocks; if the return on risk-free government securities is higher, there is less of a desire to invest in riskier assets like stocks. If interest rates go up, stocks typically go down. Conversely, as we have seen, in an artificially low interest rate environment, stocks soared.
As for corporate profitability, when the economy is doing well and companies report strong earnings growth, their share price rises. During a recession, profits slip and share prices are penalized.
That hasn’t happened this time around. Stocks have continued to climb even in the midst of an earnings recession. Investors have also rewarded companies with higher valuations simply for not losing as much money as they thought they would.
Ideally, stocks and their valuations would follow the mean. But as we have seen, stocks and valuations are not running in step. Stocks are significantly overvalued and there is every reason to believe the U.S. will face an economic crisis in 2017 and stocks will collapse.
Interest rates are going up, corporate profitability is anemic, the U.S. economy remains fragile, global growth is underwhelming, Americans are unable to find good jobs, the participation rate is near record lows, Americans are deep in debt, and have little to no emergency fund.
An economic collapse would mean Americans cut back on spending, which would undermine overvalued stocks leading to another stock market crash.