Do economic fundamentals support this market?
(Photo:
Handout)
Another
day, another record.
It's
become a familiar, and alarming, theme on Wall Street.
With
the Dow Jones industrial average within striking distance of 17,000, and the
Standard & Poor's 500 index inching closer to 2,000, it's time to question
whether this market is being supported by real economic fundamentals.
The
short answer? It's not.
New
data show the economy shrank by 2.9% in the first three months of the year,
worse than previously thought. And while many would like to blame the weather
(yes, it was bad) and look ahead to a better quarter, the reality remains that
this is an economy stuck in an anemic recovery with few signs of
improvement.
Durable
goods orders fell 1% in the latest month, meaning consumers aren't spending on
big-ticket items, such as refrigerators and washing machines. Retail spending is
still weak, and while we may be creating some jobs (in excess of 200,000 in the
past four months) the quality of those jobs is lacking.
Wage
increases are still nearly non-existent, despite the Fed injecting cash into the
system for five-plus years. Homes sales are on the mend, however much of that
real estate buying originates from investors and overseas buyers. Not a good
sign for Main Street USA.
In
addition, higher oil prices, a weak labor-participation rate and continued
regulatory overhang from Washington all threaten economic progress.
Luckily
for Wall Street, we have the Fed. This is a market that's fueled almost entirely
by our central bank. While some may argue that the Fed saved us from the depths
of a great depression, I'd recommend we all remember the law of unintended
consequences.
Though
we avoided a sharp economic decline, having record low interest rates for
five-plus years, combined with an unprecedented amount of quantitative easing
(buying Treasuries to help drive interest rates lower and keep liquidity in the
system) has done little to improve the lives of everyday Americans and instead,
may be resulting in a big unintended consequence — the creation of an asset
bubble in both stocks and bonds.
Cheap
money is pushing investors further out on the risk curve. With interest rates at
record lows, investors searching for returns are forced into risky assets such
as high-yield bonds and equities. Instead of making rational decisions based on
real fundamental economic growth and strong earnings, the old mantra, "Don't
fight the Fed," is the one investors are living by. That's called complacency,
and there's a lot of it these days.
Cheap
money also fuels corporate buybacks and corporate mergers, neither of which
directly helps the economy, nor gets Americans back to work — but it does help
stock prices.
How
do you create real demand in a slow-growing economy?
Maybe,
just maybe, some optimism from the Fed would help.
Consider
this: If consumers and businesses believe interest rates will be the same next
year as they are today, why should they borrow money and take on risk now? With
Fed Chair Janet Yellen indicating that the Fed will continue its zero
interest-rate policy for the foreseeable future, there's little incentive to
borrow and spend today.
The
good news is, that messaging may begin to change. This past week, James Bullard,
president of the St. Louis Federal Reserve bank, told Bloomberg News that the
economy is improving enough to handle an increase in short-term rates next year.
If nothing else, the threat of rising rates can hopefully begin to spur a little
demand.
Interest
rates can't stay low forever. We saw this movie play out in 2008, when low rates
helped fuel a housing bubble that nearly collapsed the system. The question now:
Is this the sequel? If interest rates remain at zero and asset prices continue
being bid up without resulting in fundamental economic improvement, this will be
a movie no one wants to see.
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