WSJ: Acme Jetpack Market

      You’d think it’s time to stock canned goods and sweep out the bomb shelter.
      Oil is over $70 a barrel, Iran’s got nukes, and soon they’ll price gas per ounce. The Fed has jacked short rates up 15 times. Guys, you’re killing us. The yield curve is as flat as a subsidized Iowa corn field. There’s $1 trillion of teaser rate Adjustable Rate Mortgages about to burst all over Southern California and ’burbs everywhere. Gold is over $600, commodities are roaring, the dollar is dropping again, there are trade deficits as far as the eye can see and GM is on life support. Drunken sailors in D.C. are running a sea of red ink and every time it’s sunny, some antigrowth global warming nutjob wags his finger at your $100-to-fill SUV. It feels like the ’70s all over again, a blaze of malaise. Except . . .

The stock market is like the little engine that could, and seems to go up everyday. The Dow is just shy of its all-time high, the S&P 500 is over 1300 and Nasdaq has doubled in three years. Yee-ha, bull markets are fun, but something doesn’t add up. They say the stock market climbs the Wall of Worry, but this is ridiculous—it’s got the Wile E. Coyote Acme Jetpack on.
      So what is it? The stock market knows something and is predicting some future the rest of us can only guess at. I think it knows how the economy is now structured and is not letting on. It may have figured out that we’re about halfway through a transition from an industrial economy to a design economy. And all bets are off.
      Banks don’t fund growth anymore, the stock market does. A flat yield curve is less important. Why borrow at 6% when you can sell shares to fund expansion. Those that have to borrow, like GM, are rightly starved. Those that can grow unabated (Google, Goldman and yes, financial firm GE) use the stock market for funds.
      Perhaps here’s how the world works these days. No need to borrow billions and build big ethylene plants anymore. You invent something here (chip, movie, iPod, medicine, financial instrument), email the design overseas for manufacture in $1-an-hour factories (OK, not financial stuff), and then ship it back for consumption. Sure, this runs up trade deficits, and our precious dollars leave the country, but that’s only half the story. Those dollars come back and invest in the U.S. Most go into long bonds, 10-years and 30-years. That’s why Alan Greenspan left with a puzzled look on his face. Foreign buying is keeping long rates low; the yield curve is flat.
      But maybe the stock market has figured out that we’re running out of long bonds. Maybe, just maybe, the surprise is fiscal discipline being voted into office in November and shrinking red ink in D.C. Marginal rate tax cuts and lower rates on dividends and cap gains might actually work and increase revenue. If we run smaller deficits, then there’ll be fewer bonds for foreigners to buy, so they have to buy something else with those dollars and the next big pot of liquidity is—hmm, let me think for a second, oh yeah, on Wall and Broad, the $15 trillion stock market. When bonds are scarce, foreigners are going to have to buy our stocks, or so the stock market might be screaming.
      It may also be saying that gold is dead, our economy is structured to generate a return on investment on even $70 oil, trade deficits are actually a good thing, innovation will resolve long-term health-care liabilities, and that lower prices for beach-front homes won’t derail the economy.
    But make up your own mind. The time to load up was three years ago. The stock market is notoriously schizophrenic. Remember, it thought you could sell pet food over the Internet. But it’s more often right than wrong, especially when proving pessimists wrong and optimists delusional.
      Andy Kessler’s next book “The End of Medicine” will be published by Collins in July.

Comments

[Barry Ritholtz]

Andy,

It appears that you are mashing together two distinct phenomenon. One is all the excess liquidity sloshing around the world. That's why many indices are at record levels.

If you break it down, these record highs are less impressive: The 5 year highs in the Dow are the rersult of annual returns of 3%. Forgive me if I am underwhelmed.

Even this year -- the best 1stQ in 6 years we were told -- if you bought the Nasdaq 100 the first week, you have been under water the rest of the year. Again, underwhelming.

As tot he design economy -- that's all well and good. It works great for ETFs, for Apple, AMD, and Google -- but these design companies are not the lion's share of the economy.

The longer we consume more than we produce, the greater the net assets we transfer to other countries. Like $75 Oil and other macro-economic phenomenon, it doesnt matter and won't -- until it finally does . . .

PS I enjoyed Wall Street Meat

[Ward Good]

The service sector is the lion's share of the economy and the character of small businesses, the lion's share of employment has changed dramatically in the past few decades while economic statistics apparently have not.

[paik]

I think you're a bit too optimistic.

What makes you think foreigners will continue to buy US Bonds or even your equities when the dollar is falling precipitously, especially here in Korea. The falling dollar is setting new directions into the Central Banks of China, Japan, Korea and Taiwan. We would have to wait and see due to America's presence in foreign affairs keeping Asians continously buying its treasuries but with US's decreasing power I'm pessimistic. It is as much a political issue as it is economical. These are great bargaining chips for the Asian countries. (FTA and all)

We have seen the Swedes officially announce that they will decrease their exposure to the Dollar and buy Euros. And they've already started. This can cause a domino effect with more nations joining and choosing Euro as their investment. And lets not forget that Iran and other OPEC memebers are gradually thinking Euro as their exchange rate for its products.

I agree that some of the money leaving US treasuries will go into your equities, but the size won't be comparable and not enough for your markets to continously grow at a strong rate. I think the central banks will diversify into Euros and other international equity and bond markets, obviously leaving a good chunk to the US but less then before.

Like the man above mentioned, it's too risky to base your economy solely on the design side of economics. It's the future no doubt, but you do not want to base your economy on soley design and service which you're heading towards. You need the base to create jobs and to increase exports. What worries me the most is your excitement with your design economics. Your design companies, like google, apple, ebay, motorola, yahoos and what not are not successful overseas, especially in the biggest growing markets in Asia. These design companies make all the money in the US. It's not very competitive over here. Since your economy is based on 2/3 domestic consumption, all the buyers are Americans and that's why your design companies are successful, not because of their competitiveness overseas, because they don't have one currently. And lets not even get into your manufacturing and the hard industry side, because you need new directions there quickly.

[Manny]

I would much rather be the country of Web 2.0 than the country of cheap bathroom fixtures (i.e. China). Ideas make the money. And China HATES ideas. Especially freedom-type ideas. So they are going to be limiting the true high-margin businesses because of their own self-censorship. This mindset HAS to stifle innovation and certainy MUST stifle any innovation/creation of intellectual property. And, in the long run, it's ALL intellectual property.

[Ben Qing]

I have to agree with "Ward Good." To assume that the world will keep dumping their profits into America seems a little arrogant maybe even naive--especially while we have a numbskull president like Bush in office. God forbid we have another IR (Industrial Revolution) republican replace him in a few years. If that happens, then Mr.Kessler's economic theories will be fraught with misconceptions.

Anyway, loved "Running Money" Andy and looking forward to your next....

[kennycan]

The whole thing falls apart if other countries don't protect Intellectual Property.

[George]

Design economies, or innovation economies will always be the ones ended up on top of the food chain. In China, and other economies that got their start selling cheap goods and services to the US, they realize that they must turn themselves into knowledge and innovation economies. They know all that they are doing now is arbitraging their cheap labor or resources and selling it to us and Europe. At some point, someone else cheaper is going to come along and replace them. I can point to the gradual migration of Shanghai's textile industry several hundred miles inland as an example to the continuous need to search out cheaper labor and resources. Another example is how manufacturers who originally went to Shenzhen are now looking for new sites in Szechuan and even Vietnam. Andy's "glib" but accurate (nonetheless amusing) point that Japanese sold us all the electronic goods, got all our moeny, and somehow left it on our shores buy buying real estate point out one interesting fact: that buying in the US is still the safest thing to do. I will start getting worried when my Chinese clients start withdrawing their money from their Cayman accounts and start buying into Shanghai real estate with that money.

[thelittleendian]

In response to the dissenting comments to Andy's piece, I'd like to point out that perhaps his closing lines best address the ambiguities of the stock market -

"The stock market is notoriously schizophrenic.... But it’s more often right than wrong, especially when proving pessimists wrong and optimists delusional."

If you think Andy is too optimistic (delusional, naive?) or if someone else thinks you are too pessimistic, the stock market will prove you both wrong. The right answer is obviously somewhere in the middle and if you zoom out all the way on your temporal lens, it wont matter what that middle is.

For those of us who like to zoom in - better be alert when things start moving rapidly, try focusing then...