Which is right: Stocks or economy?
The difference of opinion between Wall Street and Main Street is growing as equities soar but growth stalls.
The stock market and the economy have always maintained a tenuous link. Equities are prone to periods of extreme fear and greed, pulling valuations around what the economic fundamentals suggest is "fair value." It gets really bad near major turning points, such as the exuberance and the "subprime is contained" falsehoods of 2007 to the terror and "the bailouts won't work" panic of 2009.
I think we're seeing another turnaround point right now as the major averages go vertical and gauges of investor sentiment reach levels not seen since the 2000 dot-com bubble; even as the economy, by some measures, shows signs of falling back into recession.
So, which is right about where we're headed?
The driver of the disparity is central bank intervention, with the Federal Reserve, the European Central Bank, and Bank of England, and the Bank of Japan all flooding the financial system with cheap cash. Much of the impetus for the market rally of the past two months has been indications the Bank of Japan is about to throw conservatism to the wind and indulge in even more aggressive monetary stimulus.
While hedge fund types love this, and a liquidity starved economy loved it in 2008 and 2009, there is just simply too much money floating around to make a difference now. The Fed's balance sheet has swelled past $3 trillion, up from $800 billion before the financial crisis, $1.4 trillion of which is simply sitting at the Fed's vaults as commercial banks have nothing to do with the money but hold it as deposits.
Moreover, as the deterioration of the economic data suggests, all this cheap money isn't preventing the natural business cycle from working its will, resulting in new recessions in Europe and Japan, with another one headed for the United Kingdom.
Things aren't looking good here at home.
The bulls Thursday ignored a terrible Kansas City Fed activity survey, which featured an employment index that sliced into recessionary territory. When joined with similarly weak results from the other regional Fed Surveys, thaw overall picture is clear: With more tax hikes and spending cuts on the way, possibly spiked with a government shutdown, the economy is already in trouble.
If all this is making your head hurt, just know it all boils down to this:
- Sentiment is excessively bullish at levels seen near major market turning points.
- Fiscal policy will be a growing drag on growth, but here and overseas, this year.
- Technical indicators remain weak with breadth, volume, and options market activity suggesting caution is warranted.
- Economic fundamentals are still deteriorating and have fallen into recessionary territory.
- With gas prices rising again, the energy market remains vulnerable to the rise of Islamic terrorists in North Africa and simmering tensions in the Middle East.
- Most of Europe, including Germany, is either in or is falling into a recession. Japan is in recession. And the United Kingdom is falling into recession as well.
Add it all up, spiked with the big price swings, market dislocations, and other drama, and this feels like a major, historical moment for Wall Street and the economy at large. A moment when the belief that central bank intervention can paper over deeper, structural issues by giving hedge funds and investment banks more money to play with about to be shaken.
We're seeing the evidence of that play out in real time.
Since the Fed launched QE3 and QE4 late last year, the economy has lost serious momentum.
And now, with the inflation hawks worrying about the destabilizing effects of all that cheap money, the clock is ticking on the "don't worry, the Fed will save us" meme that has driven this bull market. When it ends, amid political rancor over gun control and the budget in the months to come, it won't be pretty.
Just like the shattering of the illusion that profit margins at Apple (AAPL) were impenetrable -- amid increasing competition, a saturated smartphone market, and a tapped out American consumer -- has been ugly.
In response, I'm adding new short positions against industrial materials via Cliff's Natural Resources (CLF), AKSteel (AKS), and the ProShares UltraShort Basic Materials (SMN) to my Edge Letter Sample Portfolio.
Disclosure: Anthony has recommended CLF short, AKS short, and SMN long to his clients.
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For all of Anthony's charts, I never see him examine what stocks are supposed to be valued by: revenues, earnings, and margins.
He loves to look at grand market trends (him and his "head and shoulders" patterns...), but he doesn't like to write about income statements or balance sheets.
Hallucinations are part of Mirhaydari's psyche. He went to school with Roubini. Shoots from the hip.
Eventually, he gets one right.
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