“Judge a tree from its fruit, not from its leaves.” Euripides (480-406 BC)
The most powerful and most prevailing theme in this ongoing bull market run is how participants continue to credit and adore the powers of the Federal Reserve. As to those “magical” central bank powers, any glance at a financial article or journal will remind one on the strength or dangers of QE. This is a suspenseful topic! Yet, with the economic growth being quite visibly disconnected from tangible stock market appreciation, then one has to wonder about the merits of the current trend. Obviously, we’re nearing a point where the fruits of Quantitative Easing are being heavily questioned. Skepticism and uncertainly continue to build around the pending “taper” – the end of stimulus efforts under the assumption of a recovering economy. Interestingly, it was evident participants were either hedging or speculating on rising volatility:
“About 234,000 futures contracts on the Chicago Board Options Exchange Volatility Index, or the VIX, changed hands yesterday. That’s the most since June 21, as the S&P 500 (SPX) reached a one-month low, according to data compiled by Bloomberg. Trading in the securities has exceeded 24.7 million since January, 5 percent more than the 2012 total and double the level from 2011.” (Bloomberg, August 16, 2013).
It’s quite clear that perception management is what drives markets until reality comes. Yet, when there is a sudden acceptance of a painful reality, then inevitably shocks follow, causing a dent. Luckily for most of us, this concept of a “bubble” is not ancient history. In fact, the technology and real estate bubble of last decade fed into the greedy mindset while neglecting the drivers of true natural growth Experts go on and on ad nauseum about the recent bubbles of 2000 and 2008, but surely that has not changed the theatrical orchestration of rising stocks and housing markets in 2013 – at least for now. It is important to remember that in the 2000s, US GDP grew by 1.9%, much lower than the historical average, and this fact at times is overshadowed by the housing crisis. Even the inflated housing boom (consumer spending) failed to create significant economic growth. Perhaps, history is repeating itself despite the complicated and deceptive messages that are thrown around. The Federal Reserve Bank of St Louis reminded us in early 2012:
“What makes the U.S. experience of recent decades unusual is that the share of consumer spending in GDP was relatively high already before it began to increase substantially further during the 1980s, 1990s and 2000s. In dollar terms, PCE’s share of GDP in the third quarters of 1977, 1987, 1997 and 2007 were 62.5, 65.9, 66.7 and 69.5 percent, respectively. Thus, consumer spending was a large and increasingly important part of the American economy during the decades preceding the recession and remains so today.” (January 2012).
Frankly, lifting this economy post-technological boom and increasing competitive global markets has been difficult and purely unanswered. Yet, investors have been rewarded in post-crisis periods, which encourages risk-taking. If the prevailing theme deeply resorts to “relying on Fed messaging,” then this continues to repeat the obvious, well-known theme in which the central bank remains the conductor of markets. The Central Bank Chairman, through messaging alone, can influence how data is interpreted while being a key catalyst for macro events. Love it or hate it, if one is in the business of risk-taking, being a rebel or anti-Fed is not always the answer. In fact, it’s proven to be a dangerous way to manage money. Yet, being blinded by perception alone is neglecting the lack of growth that’s been visible in the US economy – regardless of political leadership, regulation, or policy implementation.
The markets easily can sniff the lack of sustainable corporate earnings versus a stale, lackluster economy on a local or national basis. In fact, the big downside surprise in consumer sentiment last week set off some early warnings for the bulls. Even with broad indexes hitting all-time highs, now the ranges appear to be in no man’s land, while the collective thought is for the trend to continue. The Federal Reserve is attempting to craft a new chapter for the autumn season. A continued rally or not, the US growth rate is not quite lively, and being distracted by other forces that ignore this reality is bound to be more costly than prior years.
Emerging markets appear to have corrected enough to attract early bargain hunters. European woes have persisted for a while, and any relief can entice speculative buyers to reexamine. Both markets took a back seat in the last few years as the US stock market outperformed. However, in recent months, strength in European markets may signal a shift. Frankly, that’s too early to tell, as a declaration of the end of the recession has plenty to prove beyond being a favorite view for contrarians. Now, the upside potential for US equities lingers: 1) Do US stocks need to retrace further? 2) Is the pending correction a synchronized global stock market decline or isolated to the US only? Answers to these questions may be found in the upcoming quarters ahead, but for now, the jittery US market feeling extends to other notable markets.
“As the Chinese economy boomed, few cities soared faster or higher than Shenmu, a community of nearly 500,000 in northwestern China. Top luxury clothing stores in this city’s downtown were recording as much as $500,000 a day in sales. Tables at the best restaurants had to be reserved weeks in advance. The new Fortune Garden Club for the city’s business elite made headlines by paying $1 million for a king-size mahogany bed, to be used by members and their companions. But a painful credit crisis is now spreading across Shenmu and cities nearby, as thousands of businesses have closed, fleets of BMWs and Audis have been repossessed and street protests have erupted. Now the leading purveyors of Western fashions are deserted, monthly sales at restaurants are down as much as 97 percent and the marble entrance to the Fortune Garden Club is shuttered. All but one of the city’s car dealerships have failed. The owner of the city’s largest jewelry store was detained by the authorities a week ago after creditors found him secretly packing millions of dollars’ worth of gold and jewels into cases and accused him of preparing to flee the city without settling his debts. A top restaurant closed a day earlier, and its owner left town, as have the founder of the Fortune Garden and many other executives.” (New York Times, August 15, 2013)
“Many economists have been expecting the housing boom to provide a visible lift to the US economy. So far the results have been underwhelming. In spite of strong homebuilder optimism housing starts remain subdued. The momentum we saw in late 2012 has dissipated and last year’s forecasts (for example Goldman and ISI Group) turned out to be too optimistic. … The hope of course is that in addition to the jobs created in construction, the indirect impact of the housing market improvement would provide a much needed boost to the economy. But the so-called ‘housing services’ sector (mostly rent and utilities), which is typically 12-13% of the GDP, grew by about 0.7% over the past 4 quarters. That’s roughly the growth rate of the US population. Clearly the ‘knock-on’ effect of the housing recovery isn’t there just yet – other than more people in the US resulting in more rent and utilities payments. … There is another trend that is probably not helping with conversion of new home activity into the economic growth some were expecting. Multi-family units represent an increasing proportion of total housing starts. It is possible that because these units are more likely to be rentals, the ‘multiplier effect’ of housing just isn’t as strong. Homeowners (living in a single-family unit) will probably spend considerably more in house-related purchases than multi-family unit renters.” (SoberLook.com, August 17, 2013).
Levels: (Prices as of close August 16, 2013)
S&P 500 Index [1655.83] – Closed last week below the 50-day moving day average (1657.40). Since peaking on August 2, the index is down nearly 3%, as early signs of a pause are building in late summer.
Crude (Spot) [$107.46] – Twice this summer, crude prices failed to sustainably stay above $108. Now for the third time, the test is looming as buyers look to revisit the annual highs of $109.32 – set on July 19.
Gold [$1329.10] – The next key level is $1400, followed by $1465 (200-day moving average). It’s a long climb back to $1600, confirming the current downtrend.
DXY – US Dollar Index [81.18] – The strong dollar momentum has slowed down in the last month or so. This has been familiar territory since 2008, in which DXY has spent plenty of time in the 77-84 range.
US 10 Year Treasury Yields [2.82%] – The explosive run since May 2013 continues. Early stability around the 2.60% range and last Friday’s (Aug 16) intra-day highs of 2.86% will mark a new upside target.