As Dave said this week; the stock market has morphed into something of a melt-up as the indices have sprinted higher in seven of the past eight days. And to the bulls’ credit, the market’s ramp has also been accompanied by solid internals, at least as it appears so far. As an example, advances were well ahead of declines on the major indices, volume was higher than Tuesday's, up-volume was about double down-volume, and our internal models have been perking up a bit.
At least part of the reason behind the market’s current joyride to the upside is the belief that the economic fundamentals are improving (I’ll take exception with this concept in a moment). As consensus the thinking goes, the economy is improving, earnings are strong, interest rates are low (and likely to stay that way for some time), and as Mr. Bernanke told us this week, inflation is not a concern. But on that score, with gold, silver, crude, etc. soaring to unbelievable heights, apparently traders the idea that the current bout with inflation is a temporary thing. Sorry Ben, nobody believes you.
I read the current market situation as a battle between two main themes.
On one side we have the positive force of an easy-money/low-rates policy. Where else does money go when short-term rates are at 0.00% and the Fed Chairman tells us they are going to stay there for quite a while? And with the Fed printing dollars like crazy, there are a whole lot of them in search of a home.
This provides a huge upward push to equity prices as well as other risk assets, while driving down the dollar (No weak dollar policy, Mr. Geithner? Really?). And a weak dollar drives up all of the dollar-denominated commodities: Gold, Silver, Crude Oil, etc.
On the other side we have the negative impact of a U.S. consumer that, unless things quickly change dramatically, could easily begin retrenching with a vengeance. If that happens, my question is where does overall top-line growth come from? And with reduced or no revenue growth, how does the market achieve the record S&P500 earnings that virtually all Wall Street analysts have built into their forecasts?
As things stand (and according to companies reporting this quarter), just about everything the U.S. consumer buys is going to cost more, possibly a lot more. And this at a time when "Official Unemployment" is still almost 9%, unofficial unemployment is much higher, average hours in the work week have been stagnant for some time now, and average hourly and weekly wages have been trending modestly lower (and that's before inflation).
It will be hard for the consumer to spend more on discretionary items when incomes are stagnant and food and energy costs are soaring. Such a situation will negatively impact consumer attitudes? And the bottom line is a consumer in a fearful mood doesn't spend freely.
As it relates to consumer attitudes consider the following:
- Gasoline will be (my opinion) soon over $5.00 per gallon. At my local station the top grade is now almost $4.60.
- Food costs are going up sharply.
- Homes are still dropping in price, with the rate of decline accelerating.
- Credit is still tight for the general consumer.
- Using one's home as an "ATM" through the easy availability of "Home Equity Line of Credit" loans is a thing of the past.
These will all weigh negatively on consumer attitudes. The only real positive inputs to consumer attitudes, recent surveys not withstanding, are a sharp drop in further job losses ("At least we both still have our jobs.") and a Fed engineered market rally that has peoples' retirement accounts up significantly in value. ("At least my 401K is almost back to where it was 4 years ago.")
My points are these:
- Like it or not, the U.S. economy is about 25% of the world economy.
- The U.S. consumer is about 70% of the U.S. economy.
- Thus, the U.S. consumer represents just under 20% of the entire world economy.
Therefore, a U.S. consumer who retrenches in reaction to; surging food and fuel costs, modestly shrinking paychecks, and a difficult job market, is not a good thing for the global economy. And if the consumer doesn't spend, where pray tell does the top-line revenue growth come from?
Add in the following:
- The surge in manufacturing and durable goods orders may have much to do with artificial stimulus such as the current tax code changes allowing for dramatically accelerated write-offs of
capital goods expenditures. The positive impact could prove transient. Recall for reference the "Cash-for-Clunkers" and "Home-Buyer-Credit" programs which very temporarily spiked activity, but
only at the expense of future business.
- Europe's economy is also roughly 25% (or more) of the world economy. And Europe and its consumers may be in even worse shape than the U.S.
- The "European Sovereign Debt Crisis" is triggering dramatic cutbacks in government spending.
- In the United States, Federal, State, and local governments are also seeing real spending cuts, not just reductions in the rate of growth. And there are real government workforce reductions
taking place.
- The U.S. housing industry is operating at a level that is about 70% down from its 2006 levels, and threatening to rollover into a double-dip.
- The U.S. auto industry is operating at a level that is about 30% lower than its levels of 2006.
Where does top line growth come from if one-half of the world's economy is struggling?
My concern is therefore that the gains in the stock markets are based more on:
- Inflation effects.
- Massive new liquidity generated by the Fed that must find a home.
- "Old" money that has been "forced" out of what are now 0% interest rate locations and into higher risk alternatives.
- And, of course, the self-reinforcing action of all the momentum players out there.
Ponder a few questions:
- What happens when the stimulus ends?
- When do the "Bond Vigilantes" target the U.S. and rates here truly begin to rise?
- What happens to all that money that went into "risk assets" only because it had to? Does it go back into bank CD's and Money Market Funds? If so, how does the Bull Market continue?
- How can the Fed tighten if the entire system has become "hooked" on near-zero rates and abundant liquidity?
- How can it not tighten in the face of the rising inflation it is causing?
Hence Ben Bernanke's comments alluding to a lessening of choices of action.
Perhaps they, and we, really do find ourselves painted into a corner with no good way out.
For now the current major trend is up and may remain so for some weeks or months yet. However, the key point is to realize that we are not in a low-risk environment.
News event will likely continue to serve as catalysts for surges and drops. The momentum players, coupled with the "carry trade" and "easy money" will continue to be a
If this market rally were only due to easy money, exchange volumes would be much higher. This is an earnings driven market recovery. When companies turn in record profits that are increasing the stock market should and will go up. Furthermore stock valuations are not by any measure extreme so there is plenty of room for further upside. A weak dollar has certain advantages for the economy. It makes it cheaper for foreigners to vacation or buy property in the U.S. but more expensive for Americans to travel overseas. Therefore we should expect to see more travel related and foreign real estate dollars spent here. It also makes U.S. exports a better buy. A lot of growth is coming from overseas markets so the notion that a global economic recovery depends on the American consumer is misguided. The next major market trend you refer to is up. The fact that people are skittish about the market with one foot out the door is highly bullish.