6/26/2013 5:30 PM ET|
Can the economy survive the Fed?
Cheap money from the Federal Reserve has been the primary force keeping the market high and the economy on a recovery path. But can they keep it up when the stimulus ends?
After the market turmoil of the last few days, the inevitable question is: Now what?
Months of calm and upward momentum have suddenly been replaced by uncertainty, volatility and fear. The Dow Jones Industrial Average ($INDU) has tipped into its worst sell-off since October. Japanese and Chinese stock indexes have entered bear-market territory, with the Shanghai Composite earlier this week testing levels not seen since January 2009.
This follows months of selling in commodities, precious metals and corporate bonds. It looks like the start of the pullback-or-worse trend I've been warning of, in columns such as "Beware: Market insiders are selling."
The central issue is pretty clear: The Federal Reserve is moving to phase out cheap-money stimulus by trimming its $85 billion-a-month "QE3" bond-buying program. The timing is unclear, but no longer can we assume that government borrowing costs, and thus interest rates throughout the economy, will remain low and docile for years to come.
The Fed's cheap money has been the key to keeping the economic recovery going and to the market's big rally and recent all-time highs. So can the economy keep going without it? Let's take a look at the road ahead.
The next few weeks
At this point, the near-term concern is how bad the market damage will be as major uptrend support is broken. Investors have been reminded that stocks can, indeed, go down persistently.
On a technical basis, things aren't looking good:
● Cyclical, economically sensitive stocks like materials and energy are starting to weaken once more compared with defensive sectors such as health care.
● The percentage of Standard & Poor's 500 Index ($INX) stocks going up has fallen at a rate not seen since the May 2012 sell-off, and before that, the August 2011 meltdown.
● The number of stocks hitting new 52-week lows on the New York Stock Exchange each day has moved to levels not seen since August 2011 levels.
● Traders are rushing into put options, which profit when stocks go down, at such a pace that they're pushing the CBOE Volatility Index (VIX) or "fear gauge" -- which is calculated based on the price of options contracts -- above its 200-day moving average for the first time since, you guessed it, August 2011.
As a rough estimate of how bad it could get before we see a relief rally, a test of the S&P 500's February low near its 200-day moving average around 1,500 should be expected at the very least -- which would represent a decline of an additional 4% or so. A test of support at the October high near 1,450 would be worth a loss of 8%.
Whether the losses move deeper than that, in the near term, depends mainly on whether the Fed pushes ahead with its tapering plans at its July and September policy meetings, or moves more slowly. And that depends on the flow of economic data. A deeper drop in inflation measures or any slowdown in monthly job gains would likely change the tone coming out of the Fed. It would show that the Fed shares Wall Street's lack of faith in the economy's strength, which the pros might find comforting.
Other factors will also shape what the Fed and the economy do next.
The next step in Japanese Prime Minister Shinzo Abe's plan to revitalize his nation's economy -- via reforms of Japan's crusty economic institutions -- hangs on parliamentary elections July 21. A recent electoral victory in the 127-seat Tokyo Metropolitan Assembly bodes well for Abe, but certainty that reforms will keep moving ahead will help the global economic picture.
Also critical: whether the Chinese continue to clamp down on credit growth in the days ahead by allowing interbank lending rates to stay high. The overnight borrowing rate jumped from less than 2.5% earlier this year to as high as 13.2% last week before settling just below 6%. If the situation doesn't calm down, volatility in Chinese equities could destabilize the region and keep pressure on U.S. issues as well.
Finally, we have the upcoming second-quarter earnings season to worry about. Alcoa (AA) kicks things off July 8. Executives have been cutting earnings guidance at a pace not seen since the dot-com bubble was bursting, amid weaker profitability and tepid global demand. Analysts are looking for S&P 500 earnings growth of 3.2% and sales growth of 1.7%; that's down from expectations of 6.1% and 3.7%, respectively, back in April.
If earnings fall and the Fed starts to gut stimulus efforts, the market and the economy would get a nasty one-two punch to the gut.
The next few months
Over the longer term, whether the economy can move forward without the Fed is far from certain.
What we don't know just yet is whether the U.S. economy is continuing to slow -- as some recent data suggest -- or re-accelerating, as the Fed is forecasting.
And while the latter sounds good, it would also mean that inflation-adjusted interest rates, which have already shot up (as shown in the graph below) are headed even higher.
That will test whether the housing market -- and all the activity by investors that has helped push it higher -- is strong enough to absorb a rise in mortgage rates.
Higher rates will also increase the government's borrowing cost and the cost of capital for businesses, and put further pressure on bond-heavy investor portfolios (the subject of my column last week, "The next big 401k wipeout").
Oh, and let's not forget that we are in a global economy. After Japan and China, focus will turn to again to Europe. As the eurozone recession spreads to Germany and a relatively lofty valuation for the euro damages export competitiveness, the European Central Bank will be tempted to deal out more cheap-money stimulus, building on its 0.25% interest rate cut on May 2.
While this would be a good thing, it most likely won't come until after German elections in September to avoid making it a political issue for Chancellor Angela Merkel. There is also a risk that German courts could throw a wrench in the works by declaring existing eurozone rescue efforts unconstitutional.
All this is a lot for the Fed to take into account in the months ahead. The complex picture is part of the reason the Fed has been committed to stimulus for roughly four years now -- and it explains why so many investors are nervous at the prospect of that one constant positive coming to an end.
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GDP 0.4 and 1.8 We all know the only thing the stimulus is fixing is the greed on Wall street.Bunch of F'N sickos.
When The Fed Reserve announces a slow down in welfare to Wall Street it means creating faux money out thin air to buy our own debt is hurting us more than helping. Main Street is still struggling with unemployment, inflation, foreclosures with stagnated and or reduced income.
To continue their QE's is financial suicide, the damage has already been done with reducing the national debt beyond hope. The truth they don't know what else except to say, oh well, we tried but failed, sorry taxpayers but you've been screwed and bamboozled.
QE moves money from people to financiers, in particular, TBTF banks and those with whom they collaborate to manipulate the economy to take money from citizens.
Do you support QE? I think it is treason.
ah yea..listen to this insanity 'Cheap money from the Federal Reserve has been the primary force keeping the market high' the only reason the market is even remotely high ..' duh!
and now the last part..' and the economy on a recovery path' huh?? you mean to tell me that this recovery path is only due to stimuli after stimuli after stimuli?? No!! you're kiddin!!! the phuck you say!
translation: this entire fiasco is a farce, a joke, a treasonous, duplicitous phony obama regime smoke and mirror 'pay no attention to the man behind the curtain' chicanery, the Ponzi scheme that surpassed the Madoff one quite easily, obama and his ilk belong in the same prison Madoff is in!
what a colossal joke on the American people and of course once the stimuli are turned off, and they have to be since we can't keep throwing money at a disaster like this indefinately, then what??? another crash?? eclipsing the previous ones??
hey America! you voted for your own demise, for obama the architect of your demise along with the democraps you keep voting in and now!, burn for it! and osamacare is just round the corner, have fun parting with $5000 a year for your MANDATED unaffordable health care plan, ah the price for 'FREE'!!, from the job you no longer have or the temp you can find, if you're lucky, that's quite the dent in your wallet ain't it, oh and if your a family, of 2, 3 or or more, get used to living in your car! the price of white guilt, stratospheric isn't it!
Yes, we'll do just fine. Volatility during the summer is almost a guarantee. You should already have positioned yourself for at least the next 3 months as the end of QE arrives. 'Uncle Ben' has stated that he'll take QE down in intervals, not all at once - If you've noticed the last few day's, we've come back up - and the Fed really hasn't done anything yet - just talking about it now.
Going though the summer, look at utilities & entertainment stocks. Why ? No matter where you live, your running your A/C more now aren't you ? And theme park attendance is up this year - even with Disney's price hike of $95.00 a person.
A couple weeks ago stock go up so high, economy doing great. A week later it goes down a lot, oh no economy doesn't do that great. Then stock go up again. Then down again.
Wow! This economy go up and down every seconds...
No fundemantal or value.
Economy doesn't reflect with the stock market.
Welfare for the rich and stock traders
Corruption/Crook = GOVERMENT = CEO
Fat Cat said:
["Florida? What a POS state. Full of Mexicans, Cubans, Blacks, white trash drifters, and Canadian Snowbirds.
It's amazing how many folks here think that the Fed operates on auto-pilot. They're thinking that they will automatically shut the QE down. Not so fast ! In fact, if economic conditions do not improve, the fed might even increase these as stated by William Dudley of the NY Fed. While there is much discussion on this, any moves the Fed makes will be based in REALITY ! If the economic data suggest changes, the Fed can go three different ways:
1- Do nothing. Keep the stimulus just like it is into 2014.
2 - Tapper down- when employment comes in close to that target number of 6.5%.
3 - More aggressive stimulus - Unemployment remains above 7% & consumer confidence tanks during the summer & into the fall when Obama care kicks in.
So the 'jury' is still out on all of this. Stay rooted in reality and not so much in speculation.
All of the manipulation by the feds will have reprecussions for years to come. I don't see how all this cheap free money is going to be paid back by a broke country! I don't pay attention to the stock market cause its like playing the slots at the cassino...you got to have enough sense to stop and take your winnings. 20 years from now I would not be suprised to see intrest rates at 15 percent for home loans as we'll be paying for this a long long time.
Oh one more thing;
I just closed the deal on a Donzi R-80. What a beautiful boat. Both a VIP & master bedrooms, along with live wells, bait storage, on deck freezer & refrigerator and the custom wood effects are just gorgeous. Lobster mini season starts 7/ 24 &25. Regular season starts first week in August. Come on down to Florida- the water is fine ! Could be another 'summer of love' ;-)
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