The leading data that we monitor continue to indicate that a return to economic contraction is likely in 2012. Although the vast majority of mainstream analysts believe (at least, publicly) that economic growth is likely to accelerate this year, excessive debt will continue to provide a significant structural impediment to the economy for the foreseeable future. As clearly demonstrated by studies such as This Time is Different by economists Carmen Reinhart and Kenneth Rogoff, our current levels of public and private debt will constrain growth until they are materially reduced and further attempts to address the issue through the introduction of additional debt will only compound the problem.
As noted by economists Van Hoisington and Lacy Hunt in their latest quarterly report, median household income continues to plunge and it is approaching levels last seen in 1995. This decline in income, coupled with the historic level of private debt, will prevent the consumer from contributing meaningfully to GDP growth.
Of course, many analysts point to the recent rebound in the stock market as evidence that the economy is healing, but the extreme gains in stocks during the last two years are due in large part to government stimuli as Federal Reserve Chairman Ben Bernanke has attempted to drive investors out of safe instruments and into speculative assets such as equities.
This process is readily apparent in the monetary data supplied by the Federal Reserve. While M1 money supply has surged more than 60 percent since 2008…
…the velocity of money has plunged more than 30 percent and the money multiplier remains well below 1.0.
As we often note, the Federal Reserve can attempt to spur economic activity by introducing monetary stimuli, but it cannot force banks to increase their loan and investment activity. The velocity and multiplier data trends clearly demonstrate that the newly introduced M1 supply is simply remaining idle in places like bank reserves. Chairman Bernanke understands the dilemma, but he would prefer to deal with any problem except deflation, so he has committed to flooding the system with liquidity for the foreseeable future and worrying about the consequences later. Bernanke believes he has the tools and expertise required to prevent these unprecedented structural imbalances from engendering massive economic disruptions when they are purged from the system some years from now. However, seeing as no central bank in history has been able to accomplish that feat, we have our doubts.
In this secular environment, the stock market will continue to experience violent cyclical moves higher and lower. The bull market that began in March 2009 is 37 months old and, given the average duration of cyclical uptrends that occur during secular downtrends, the rally is likely in the final stage of its development.
Although the mainstream view continues to believe that the current cyclical uptrend still has 12 to 24 months of gains ahead of it, our analysis indicates that the rally could terminate at any time, if it has not already. Our long-term computer models issued a bearish signal in early April that would be confirmed by renewed weakness during the next three months, so it will be important to monitor stock market behavior closely.
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