US economy

It's a lay-up: buy stocks!

cowboy bull“He may look like an idiot and talk like an idiot, but don't let that fool you -- he really is an idiot.”

- Groucho Marx

John Ross asked me this morning if I could create a scenario whereby stocks fall.  I laughed and said, "Well ... no!" And maybe that is the point. No doubt 'if you are not long, you are wrong' is playing out in spades. But we’ve seen that sentiment many times before near tops.  

The primary thematic shaping up seems the idea that bonds have topped and as this money leaves bonds it will power stocks higher—globally. The idea seems to make sense; but often it is never that easy.  Taking a look at the chart below, there doesn’t seem a heck of a lot of correlation to hang your hat upon, only to say the long-term trend higher in bonds (lower in yields) has been met by a corresponding big run in stocks.    

Let’s consider some reasons why US stocks might NOT go a lot higher and, for grins, maybe even, dare I say it, “correct.”  

  1. A recovery in the US economy could mean finally financial assets will start competing for funds and the Bernanke Put, i.e. QE moral hazard liquidity juice, fades. Bonds would get hit here, but stocks might at least correct.

  2. Bernanke’s concern the job market is still not healed may play out because fiscal stimulus fades as the year progresses. Thus, we have well below trend growth and rising prices for energy and food leading to at least a mild case of stagflation; that isn’t good for either stocks or bonds.

  3. Germany decides to go “all in” and throws its full faith and credit behind a Eurobond for the Eurozone. Immediately, the risk profile improves in Europe. S&P and Moody’s decide it’s time to upgrade European paper and at the same time downgrade US paper given that Washington can make no real cuts amidst ideological squabbling. Lots of capital flows back to European bonds and stocks and out of the US; a possible triple-whammy out of US assets (stocks, bonds, and the dollar).

  4. China financial and social unrest ramp up and the Communist Party is at odds on stimulus given their concern about inflation; therefore it’s better to have security locally than worry about Western markets; the additional stimulus never arrives as growth and demand forecasts for China ratchet lower. Likely bad for stocks, but maybe good for bonds.

  5. Eurozone. 'Nuff said!

  6. Rising emerging market capital controls a la Brazil (tacitly condoned by the IMF) are met with rising trade tariffs from developed countries.  Money flows out of risk assets (stocks), quickly from the periphery, and back into bonds as global trade falls.

  7. Republicans win the White House and Congress, fire Ben Bernanke, and make Ron Paul Fed Chairman. They cut the budget deficit twice as much as what Paul Ryan is lobbying for. Ultimately it would be the best thing that happened to the US financial position in a hundred years, but there would be hell to pay as US credit drains from the global economy (and we have to listen to the moochers whining and crying about “fairness” day in, and day out). US bonds rally big time, so does the US dollar; stocks would likely be hit very hard initially, then stage a gargantuan rally.  [I know; but a guy can dream.] 

For now, “don’t fight the Fed” and “the trend is your friend” are winning the day. And if the bulls are right about US recovery, European healing, and new Chinese stimulus soon on the way, it could keep running. No doubt.  


Rising Payrolls vs. Declining Consumer Sentiment: Who Wins?

We don’t specialize in the stock market, but we spend a lot of time trying to understand why the stock market, as a whole, might rise or fall. It helps us understand capital flows across and between global financial markets.  

Much ink has been spilled lately about a “real” recovery in the US having arrived ... finally.  

Sure, some recent data suggest recovery. But is it any different from the last time the R-word was in style?  

032012 GI ad

Here are a couple items atop the recovery evidence list:  

- Rising payrolls

- Falling unemployment

- Rising inflation  

There is more, like regional Fed data and manufacturing indices and retail sales. For good reason, the US stock market has outperformed its foreign peers based on the expectation that growth in the US will be relatively better than growth in other developed economies.  

But could recovery optimism, and US stock market gains, be derailed?  

It is said payrolls are a lagging indicator of growth. They can be influenced very much by market and economic sentiment. (Though I suppose rising payrolls can reinforce improved sentiment in a self-fulfilling fashion.)  

A popular stat being passed around lately is the impact rising crude oil has on the economy. That is, for every $0.01 increase in the price of crude oil $1 billion is sapped from consumers.  

Of course, the actual impact of crude prices on economic growth can be debated. Some say the withdrawal of discretionary spending due to increased spending on gasoline still makes its way through into the economy and thus won’t necessary stunt a recovery. But even there, the overall impact may depend a lot on the pace of rising fuel prices (faster increases mean greater negative impact on consumers.) And turning to sentiment again, consumers may postpone discretionary spending based solely on uncertainty in fuel prices.  

Here is a couple Reuters charts from two weeks ago suggesting what high prices might mean for payrolls and economic activity (note the simultaneous growth in payrolls and oil prices as well as the subsequent collapse):          

032012 crude and payrolls

And note the speed at which the ISM manufacturing index dropped once crude topped out:

032012 crude and ism resized 600   

But rather than monitoring payrolls (in case they are merely a lagging indicator) perhaps it makes more sense to monitor consumer sentiment:      

032012 consumer sentiment resized 600

Consumer sentiment turned sharply higher in the third quarter of 2011, before the payrolls began showing noteworthy increases in the first few months of 2012. So what will win? Will the added jobs prop up consumer sentiment? Or will persistently high gasoline prices weigh down on sentiment and manifest itself in the form of a drop off in payrolls?  

Bloomberg, last Friday, suggested the latter may be starting:  

Confidence among U.S. consumers unexpectedly dropped in March as this year’s 17 percent jump in gasoline prices threatens to squeeze household budgets.  

The Thomson Reuters/University of Michigan preliminary index of consumer sentiment fell to 74.3, the lowest this year, from 75.3 the prior month. The gauge was projected to rise to 76, according to the median forecast of 70 economists surveyed by Bloomberg News. A government report today showed that consumer prices rose in February by the most in 10 months, with gasoline accounting for 80 percent of the increase.  

I would guess the powers-that-be are in full PR mode, willing to do whatever it takes to bolster consumer confidence (after all, it is an election year.) So it will be particularly interesting to see how the Federal Reserve handles QE3/low interest rates/rising prices, because shoring up sentiment is very much what monetary policy has been hinged upon.  

The Fed will stay loose as they monitor how the economy responds to fuel prices. But if and when economic data responds to high fuel prices and dips in consumer confidence, the Fed looseness cease to be a factor for equities, at least in the short-run.