This week has shed light on the stock market’s inefficiencies, particularly its role in separating the optimistic from their resources. When a naive investor puts their trust in Wall Street, the inevitable outcome is a diminishment of their wealth. To put it simply, in this game, the house always comes out on top.
Ralph Waldo Emerson once stated, “Patience and fortitude conquer all things.” While this sentiment holds true, it seems Emerson could not have envisioned today’s ongoing bear market, which has plagued us since the dawn of the new millennium. Still, patience and perseverance will eventually prevail. However, what happens when your retirement savings are depleted by that time, or when the funds earmarked for your children’s college tuition run out prematurely?
Bear markets tend to reveal truths about the financial world. For instance, one particularly misguided notion that has emerged from the vigorous bull markets of the 1980s and 1990s has now been exposed. This is the fallacy propagated on Wall Street that simply investing in an index mutual fund will guarantee a millionaire’s retirement and a life of relaxation.
Back in the year 2000, this statement was widely believed; however, by 2011, the reality of this assertion became glaringly apparent.
On March 24, 2000, the S&P 500 index was valued at 1,527. Fast forward to yesterday, and it closed at 1,239 — a staggering drop of nearly 19 percent over the past 12 years. And this is not the whole picture.
According to the government’s inflation calculator, it now takes $1.32 to purchase what $1 would buy in 2000. This means that, on top of that 19 percent loss in the stock market, your savings have diminished by an additional 24 percent since the millennium began. What is going on?
Before we delve deeper into this topic, let’s take a moment to discuss the situation with Italian bonds and German bunds.
Bond Spread Blowouts
We’ve examined this issue numerous times, and we will continue to do so as we’re left astounded by the disintegration within the Eurozone. Where should we even begin?
The Greek bailout was never truly about Greece. Instead, it was primarily aimed at rescuing French and German banks that extended loans to the Greek government, loans that it was unable to repay. Following the formation of the Eurozone, there emerged a tacit understanding that Germany would underwrite the fiscal responsibilities of other Eurozone nations in case of default.
As anticipated, less credibly rated countries like Greece, Spain, Portugal, Italy, and Ireland mishandled the influx of inexpensive credit, borrowing and spending uncontrollably like American consumers. However, for every euro that Greece borrowed, there was a willing lender. Ultimately, the repeated bailouts of Greece were just veiled bank bailouts.
Recently, the spotlight has shifted from Greece to Italy, with lenders beginning to doubt Italy’s ability to meet its financial obligations. Yields on 10-Year Italian bonds soared to 6.25 percent. At week’s end, European lenders began to worry if Italian debt was beginning to mirror Greek issues.
Confirming those fears, on Wednesday, 10-Year Italian bond yields surpassed 7.4 percent, coinciding with Prime Minister Silvio Berlusconi’s pledge to resign. The yield spread between 10-year Italian bonds and German bunds expanded dramatically to 5.53 percent, up from just 1.5 percent a year ago. Alarmingly, French and Spanish bond yields are also hitting record spreads against German bonds.
Making the Impossible Possible
Meanwhile, here in the United States, investors were eagerly lining up to purchase government debt as if it were a popular treat at a fair. On Wednesday, yields on 10-Year Treasuries dropped to a mere 1.95 percent, marking nearly a record low.
Upon first glance, this situation might indicate strong validation of U.S. creditworthiness, suggesting why the world would lend money to its government at virtually no cost. However, the underlying issue is that, for the time being, the U.S. is simply the least problematic option among its peers.
The stock market’s decline of 19 percent over the last 12 years can be attributed to an ongoing bear market—something that occurs periodically. Ideally, it should be left alone to rectify past misallocations from boom periods. Unfortunately, thanks to the Federal Reserve’s persistent infusion of cheap credit aimed at stimulating the economy and propping up stock values, the real value of your savings has diminished by 24 percent. Besides this, there are other disturbing trends.
Currently, Bank of America Certificates of Deposit offer an annual percentage yield of just 0.35 percent. According to the most recent Labor Department report, the Consumer Price Index rose by 0.3 percent in September, translating to a staggering 3.6 percent on an annual basis.
Consequently, just within a month, inflation will likely eliminate almost the entire annual real return of these CDs. Over the span of a year, that CD investment is projected to yield a real return of -3.25 percent.
This scenario seems logically impossible, yet it has been made feasible by the Federal Reserve’s aggressive intervention in financial markets. The repercussions of this situation may be far worse than we can anticipate.
Sincerely,
MN Gordon
for Economic Prism
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