Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
By Tom McIntyre
September 18, 2012
Last week the stock market got all it wanted from the Central Banks of Europe and here at home. The money presses have been put on full power. The result was a continuation of the stock market rally along with commodities while bonds suffered a setback as investors swapped out.
As the charts above illustrate, the Dow Jones Industrial Average gained over 2% last week while the NASDAQ Composite jumped 1.5%
on excitement over Apple’s latest generation of cell phones.
The Market & Economy
The European Central Bank received the go-ahead from a German Constitutional Court to proceed with its plans to buy sovereign bonds in troubled countries such as Spain and Italy. There will be so-called conditions etc… but the message is clear - the Central Bank is now willing to, in essence, be the buyer of last resort for financing the budget shortfalls in these or other countries. This has had the immediate effect of taking the pressure off the bond markets of Europe without the ECB having to even buy one bond.
Obviously this is a relief to the financial markets, but it is hardly the sort of long-term policy with which the Euro zone can hope to move forward. It remains to be seen just how long this con job can succeed. Already the support for it is very low in important countries such as Germany, Holland and Finland. They, of course, are important because they are examples of the few remaining Euro zone countries that are still fiscally prudent, and thus exposed to this ECB policy of financing sovereign deficits.
Here at home things are so bad that the Federal Reserve Board has officially hit the panic button. In announcing its intention to initiate yet another round of quantitative easing, the Fed is explicitly saying things are not improving and not likely to. How does this square with President Obama’s message that his policies are working?
The Fed now has issued an open-ended promise to buy $85 Billion of assets, mostly mortgage backed securities, per month, until the unemployment rate has fallen significantly. In addition, the Fed has served notice that the current zero-percent interest rate structure will persist for at least three more years.
In essence he is telling investors in very strong terms get out of bonds and CD’s etc… and buy stocks, commodities or other risk based assets. The Fed wants to encourage this asset switch in order to stimulate demand and even inflation. The consequences of this policy over the next several years are not known. Gold, oil and stocks though did rise, so the initial reaction has been positive for the markets.
The impact on the economy is likely to be confusing if not disappointing. Rising prices for energy and food items will hurt consumers even if investors are smiling. How this plays out will be curious. Certainly, the impact on the fiscal side of the equation is confusing. In this morning’s Wall Street Journal an editorial points out the “dangers of having the government through the Fed and its expanding balance sheet become the entire banking system”. Even worse, one where the price of money (interest rates) is centrally determined.
All of this is taking place at a time when our federal government is running in excess of $1 trillion annual deficits which are financed by the Fed through its manipulation of the markets. We are in uncharted territories but common sense tells you that as more and more of the economy is dominated by the government spending (federal spending is up one trillion dollars since 2007 in a no-growth economy), and most of that is being financed with funny-money, that a day of reckoning is out there somewhere.
The news on the economy continues to show problems as the Fed’s decisions imply. Industrial production is falling and unemployment claims are rising. The growth rate for the 3rd quarter will be lucky to be above 1%. However, stocks are about profits and dividends and not GDP growth. Many companies are doing just fine, and it explains why the market is at or around five year highs.
What to Expect This Week
The Jewish holidays will see many participants absent, and so a few quiet days are to be expected. The flow of macro events which we had last week will also be absent.
The oil markets are watching the sad news out of the mid-east carefully, and the risk is high that events there may get worse. Believe me the unrest in Egypt and Libya are not because of some video that no one has even seen. The events there are a rebuke to America and our allies and need serious thought.
Finally, the update on the ECRI shows continued improvement from their weekly index (see chart below). Despite this improvement, the folks there have repeated just last week that the USA is already in recession and as the data is revised the verdict will become clear.
They may be correct, but I continue to feel that slow growth yes, but recession no. One of the reasons is that despite the Obama administration telling us in 2010 that the recession was over, it never has been. The Fed’s policy statement last week tells you all you might want to know in this regard. Thus since we never bounced back in any significant way it is unlikely that the economy can fall the low output levels we are currently seeing.
(c) McIntyre, Freedman & Flynn