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Red Friday : The Trajectory of 21st Century America?

1/26/2014

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A day after one of the worst sessions of the year, the stock market took a decidedly more aggressive tumble, with all three major indices absorbing 2% losses. On paper, this doesn't sound like much, and it really isn't. Technical analysts (known by the term "technicians") will cite the psychological impact of losing the 1,800 point threshold for the S&P 500, and the 16,000 mark for the Dow Jones. While trading behavior does indeed have a psychological (some might say psychotic) element, the above concern is merely semantics. We could easily recover those metrics, just like we know that eventually, the bathroom door will open : the more pertinent question is, how long can I hold it?

For the American economy, this is a very complicated and bifurcated answer. The common criticism that is cited within the duality of our entire political spectrum (we only have two parties that have a realistic chance of winning meaningful elections...really!?) is the national debt, which stands somewhere north of $17 trillion...I lost count. Though it is a serious burden, it's not the worst nightmare scenario for our policymakers and their think tanks ; our debt is mostly comprised of public debt, which in accounting terms, is an asset owed to the people of the United States. Contrary to internet conspiracy theories, doom and gloom hucksters, and The Second Coming of Christ (Revised Edition) movement, China is the largest holder of U.S. Treasuries amongst foreign entities. As a total amount, this is a minority allocation of America's debt. Besides, given the superiority of our military, I doubt that anybody is going to collect on us.

No, the real problem is the American consumer and their illiquidity. People are so cash-strapped that only those with cash (comprising a smaller and smaller percentage) are spending. And when consumer spending goes down, corporate revenue goes down. And when corporate revenue goes down, earnings goes...up?

Ah! This is where things start getting interesting. The Wall Street jargon is that we are still in the midst of a great bull market and that the current correction is a perfect buying opportunity. Implicit, and in the case of famed analysts such as Jeremy Siegel, explicit in the aforementioned marketing message is that markets are undervalued. We are told that markets are steadily holding at around a 17 P/E ratio, hardly a measure of irrationality.

But since we have incontrovertible proof that Americans are not spending, where is the engine that is used to justify such an "undervalued" P/E? Company executives undoubtedly recognize the deflationary nature of the current economy and have taken appropriate action, whether that be cost-cutting or corporate mergers. Applying these tactics can certainly boost earnings even when industry share as a concern of totality shrinks, but it also raises the question of how long the cannibalization can last?

As we have seen on Red Friday, the answer is "not long." Other companies will do better, sometimes extraordinarily so, against the mainstream competition. But by and large, the economy faces a reconciliation of all the accounting tricks that have gone uncontested. At some point, Peter will get pissed and will take his money from Paul.

It's an inevitability that will have consequences for the unprepared.


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