Why is the stock market rising?
Don't watch what CEOs say; see what consumers do
Why is the stock market rising?
Despite all the surveys of business owners this winter who say the economy is tanking (see for example First Niagara's Philadelphia-area sampler here), the stock market is up again, with the S&P 500 finally approaching its 2007 high.
What's up with that? "You should not worry about a collapse in consumer confidence when the reason for the change was politics-related," and same goes for "executive confidence," despite all the negative CEO polls late last year, writes Holland, Pa.-based economist (and sometime Inquirer columnist) Joel Naroff PhD in a note published by Conner Strong & Buckelew (whose boss, George Norcross, is an Inquirer owner).
"There were a lot of non-fundamental economic factors that were driving the business leaders’ responses. The government may have been creating uncertainty but the economy was still recovering nicely." See, for example, "the surge in durable goods orders in December. Even excluding both defense and civilian aircraft, demand was still up solidly.
"Indeed, the only major category where orders moderated was computers. That may simply be due to people doing their work on mobile devices as communications equipment orders jumped again... Despite the jump in orders, backlogs fell. Firms were getting the goods out the door for the end of the year as shipments rose dramatically.
"It appears that growth in the last portion of 2012 was a lot better than most had expected. We get the first go round on fourth quarter GDP growth on Wednesday... The latest Blue Chip [Economists'] Panel consensus has fourth quarter growth at 1.3%, making my 2.6% estimate a true outlier. Of course that was the same situation with third quarter growth and I was... dead on... The economy really is moving ahead decently. In the last quarter, vehicle sales were up at a 16% annualized rate, retail sales posted a nearly 6% annualized rise while housing starts exploded by an 81% annualized pace...
"Most importantly, business investment, as represented by non-defense capital goods orders excluding aircraft rose at a 21% annualized.
"The one major worry was that business leaders, fearing for the future, would not invest. That hardly seems to have been the case. So, where could the weakness come from?
"The trade deficit may have widened and who knows what is going on with government spending. But that is it... The economy that everyone continues to bemoan is actually steadily coming back."
Not all observers see the data as quite so positive. "December durable goods results continue to show a weakening environment," warns John Baliotti, industrial analyst at Janney Capital Markets in Philadelphia. While defense orders were strong, 28 civilian capital-goods categories (of 32 total) showed "negative trends" in December, worsening last fall's trend. "We expect these weak trends to pressure manufacturing production levels.
And yet industrial stocks keep rising, Baliotti acknowledged: "Investors appear willing to absorb near-term risk as we wait to see a sustained turn(around) in the manufacturing sector."
What are investors thinking? James Meyer, chief investment officer of $1 billion-plus Tower Bridge Advisors, sees the rally as more of a Fed-driven bump. In a note to clients of Boenning & Scattergood, Meyer writes:
"Stocks rallied once again as stocks are set for the best January performance in more than a decade.
"Everyone is questioning the strength of this rally and whether it can continue. Clearly, the rally isn’t a function of a sudden shift in economic activity. Fourth quarter GDP is likely to be half of what it was in the third quarter and the first quarter of 2013 will bear some impact from the payroll tax increase that took place on January 1.
"True, housing has been great. The only hold back is the lack of homes available for sale. Consumer confidence is high but disposable income remains under pressure.
"It isn’t earnings either. While many companies are beating estimates as corporations report fourth quarter results, those expectations have been pounded down for the past three months. We have seen this story play out before without precipitating a rally as strong as the current one.
"If economic and earnings news can’t explain the rally, what can? I think there are two major factors:
"The first is the huge flush of liquidity pouring into markets from central banks around the world. The second is the resolution of the fiscal cliff and the fact that Republicans have pushed out the debt ceiling extension debate until after the fight over the sequestration...
"Central banks didn’t just begin to expand their balance sheets in January. They have been doing so in some manner since the financial crisis began... Over time, as the recovery took hold, investors began to take more risk. But they did so ever so slowly.
"For the most part, taking more risk meant buying riskier bonds. At the high of the recession, junk bonds yielded 15 percentage points or more over Treasuries. Today, that yield differential is close to three [percentage] points...
"But at some point, prices get too high to entice enough incremental buyers to keep them rising. That wall appears to finally have been reached in the second half of 2012. Market watchers have been labeling the bond market a bubble for a very long time just as they labeled the housing market a bubble long before it crashed. The same can be said for Internet stocks in the late 1990s.
"Bubbles all have common characteristics. The current bond bubble wasn’t an accident; it was purposefully manufacturing by the world’s central banks. The Fed continues to buy $85 billion per month of mid-long dated bonds for the express purpose of propping prices up and holding rates down. But even the Fed can’t force rates lower if there are more sellers than buyers...
"Finally in the second half of 2012 stock markets materially outperformed bond markets, not just in the United States but all around the world."
How long will stocks rise, and bonds fall? "There will come a time when the Fed and other central banks take their feet of the accelerators... the Fed will stop buying $85 billion of debt securities every month... Central banks run a risk that as excess capacity is utilized and as inflation picks up, they will wait too long to adjust" and dump assets, crashing the economy.
"The Fed claims to understand this and claims to have the tools to withdraw liquidity at the proper time. We all believe we can jump off the train before it goes off the cliff but we seldom do. That is why bubbles are often followed by crashes."
So, when the Federal Reserve Board of Governors meets this week, chairman Bernanke "will have to acknowledge some improvements within the economy and some reduction in political risk. But the real question is whether it will drop any hints as to when it might pull back on the amount of monthly bond purchases." Any hint of a pause may stall the stock market rally.
See also the employment report, due Friday. This is a counter-intuitive indicator: "If the employment gains are robust, it will elevate fears that the Fed will take away the cookie jar sooner rather than later," and stocks may, perversely, fall. Investors will also be staring at the average hourly wage, which jumped in December and could start spooking inflation fears among conservative ideologues like Prof. Charles Plosser, who heads the Federal Reserve Bank of Philadelphia.
In sum: "The combination of rising stock prices, rising home prices and lower unemployment is a winning combination... Even Congress may be giving the economy a boost," trimming spending, possibly reforming immigration, and easing off on default talk. "We will all end up winners as a result."
But don't get too confident: "If you want to think longer term to the next real problem, ObamaCare kicks in next year and not until late 2014 will we get the first hint of the program’s true cost. If it proves much higher than originally forecasted, as seems almost inevitable, then both parties are going to have to dig in and figure out how to control health care costs."