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Goldilocks and the Not-Too-Hot, Not-Too-Cold Economy

0 | By Shah Gilani

If you’re wondering how the stock market’s been able to keep making higher all-time highs, “It’s the economy, stupid.”

That’s what campaign strategist James Carville told then-presidential hopeful Bill Clinton the American people wanted him to focus on during his 1992 successful run against incumbent George H.W. Bush.

For years now, America’s Goldilocks economy – growing not too hot and not too cold – has been driving investors into stocks.

It’s not stopping.

The economy’s going to keep humming, and the market’s going a lot higher.

Today I’ll tell you why…

These Interest Rates Are Just Right

Low interest rates have been the key driver of both the economy’s growth and the market’s assent. And while the Federal Reserve may tinker with them, those “just right” low interest rates aren’t going anywhere near “too hot” or “too cold.”

Low rates make it easy and cheap for consumers to borrow and for businesses to raise capital.

Those two positive drivers of the economy, bankable consumers and businesses, generate steady (if not steadily expanding) consumption and production. Those are the main ingredients for economic growth, corporate profits, and rising stocks.

Stocks, as an alternative investment, look a lot better when compared to low-yielding fixed-income investments.

Stocks offer a higher yield than bond investments with a maturity of less than 10 years and an investment grade rating, whether it’s the dividend yield on…

  • Lots of stocks and real estate investment trusts (REITs),
  • the entire market based on the S&P 500, or
  • the Dow Jones Industrial Average.

As far as the Fed raising rates and ruining the party by “taking away the punch bowl,” that’s not going to happen.

Short-term rates can probably go another 100-150 basis points higher and not make a lot of difference to consumers and businesses as long as their rise is slow and steady. And that’s if they’re even raised that much in the next two years.

The Fed engineered the economy’s rise from the Great Recession and the stock market’s rise to all-time highs based on keeping rates low to generate a “wealth effect,” as well as other positive risk-on attributes to encourage consumption and stock market investing.

They’re not about to kill the golden goose they’ve been fattening for 10 years because worry-wart economic theorists think rates should be based on where they were historically.

That’s old history.

This is the new economy, and rates aren’t going much higher.

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Time to Embrace Inflation

Any discussion about interest rates immediately leads to talk about inflation.

The only problem is there’s no inflation to discuss. However, that’s a (small) problem, because we don’t have enough of it.

One of the principal goals of central bankers’ low and no interest rate policies was, and is, to generate inflation – lest we don’t end up with deflation and a global depression.

They’ve failed so far.

In fact, there’s no meaningful inflation in the United States, or anywhere in the world’s major economies.

Some wage inflation would be a good thing, since it would put more money in consumers’ hands.

But, businesses passing along higher labor costs, triggering some wage-price spiral reminiscent of the 1970s, is never going to happen in the new economy. Technology is seeing to that.

Consumers are driving both the economy and corporate earnings higher.

Target Corp. (NYSE:TGT) CEO Brian Cornell, on the occasion of the company’s blowout earnings, called the current consumer environment “the best I’ve seen in my career.”

The same can be said for Target’s stock, which hit another all-time high this week.

Target’s not alone. U.S. retail sales are growing at better than Goldilocks rates, and so is consumer confidence.

A Conference Board survey last week shows U.S. consumers are more confident about the economy than they’ve been in the 15-year history of the poll.

And corporations keep churning out better earnings.

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Earnings growth in the second quarter was almost 25% better than a year ago. And that’s on top of an almost 23% growth rate in earnings in the first quarter of this year compared to a year ago.

That’s three big double-digit earnings growth spurts in the last three quarters.

Listed companies are buying back their shares at a record clip with the earnings they’re enjoying, and some are borrowing cheaply to do the same thing.

The net result of share buybacks is rising earnings per share (EPS) numbers. That’s because there are more earnings spread across fewer shares every quarter.

That always gets the attention of analysts and investors.

It’s really simple: As long as the economy’s growing in this Goldilocks fashion, because consumers are out in force and inflation isn’t eating into their buying power, companies will sell more and make more.

And smart investors know that’s the recipe for higher all-time highs continuing.

Sincerely,


Shah

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