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Mike Moreland

October 24 , 2016

The Laws of Diminishing Returns and Unintended Consequences Are Still On the Books

The Laws of Diminishing Returns and Unintended Consequences Are Still On the Books

Data released in September by the Federal Reserve U.S. show household net worth reached nearly $90 trillion at mid-year, a new record.  Real estate and investment values lost in the credit crisis have been recaptured.  This “wealth effect” speaks well for consumer confidence.  This should be good news for broad economic growth; consumer spending accounts for over two-thirds of U.S. GDP.

But this is the third consecutive quarter of net worth records.  We are not seeing the strong GDP growth academic models the Feds have long predicted.  Global economic activity is positive but subdued despite extraordinary stimulus efforts.  Broad wage inflation is always on the way but never seems to arrive.  The policies that pulled us from the brink are less effective now.  One reason is their impact has not spread evenly across society.

The vast majority of direct equity ownership is by households in the top ten percent of net worth tables.  Indirect ownership – retirement plans and the like – is wide, but effectively locked up for years or decades.  Likewise, real estate ownership is broadly distributed.  However, consumers are not monetizing their home equity (like in the early 2000s), and nearly three million homeowners remain with mortgage debt above their property values.

In short, a rising tide is not lifting all boats.  A decade of accommodative policies is producing diminishing returns, and those returns are increasingly concentrated.  The wealth effect of record stock prices and higher real estate values is not triggering broad-based spending gains.  Nationally, businesses are buying others but not expanding operations.  The Fed’s “new normal” is closer to 2.0% GDP growth than the 3.0% to 4.0% recorded in most of the post-war era.

Equity markets are near record levels because of TINA (There Is No Alternative), not because of strong underlying fundamentals.  Attention to risk is fading, the expectation is entrenched that central banks will rescue us from market downturns.

This disconnect between high valuations and low economic vitality works against risk-averse investors.  History shows today’s valuations are one of the best predictors of long term equity performance.  Research by Goldman Sachs Asset Management suggests current valuations are consistent with mid-single digit returns over the next decade.  If one adds to these the likelihood that world growth will be below a pace to support robust prices the path ahead will be more volatile than that seen in several years.  And, with yields just above break-even, there is no safe haven in high quality bonds. 

These expectations bring two disciplines to the forefront: prudence and planning.  The former is time-tested.  Stay well diversified – risk will be widely distributed, losses limited, and participation in the good times is assured.  The latter is a process.  Reaching a goal requires attention to planning and the flexibility to adjust to changing circumstances. Don’t depend on past performance or the Fed.  See your Security National Bank Advisor to build plans to work for you.  

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