Many stock market bulls consistently cite one force — and one force only — for their positive outlook. Federal Reserve policy. They say …
“Forget the fact the global economy is slumping from Europe to Asia” …
“Forget the fact the U.S. economy is slumping fast” …
“Forget the fact earnings stink!” and …
“Forget the fact the euro currency keeps falling to new lows, along with European peripheral bonds!”
Why, they say? “Because the Fed is going to save us and when it does, stocks will go up!”
It may be a comforting viewpoint. But I believe it’s also completely wrong — and I’ll tell you why!
The Sorry State of the Real Economy …
Fed Chairman Ben Bernanke went before Congress this week as part of his semi-annual testimony on the economic outlook. He didn’t mince words about the state of the economy, saying in response to questions that we were just “muddling through” while most of Europe was “already in recession.”
His prepared testimony went further, noting that GDP grew at a slower rate in the first quarter than in the second half of 2011 … and that the second quarter looks even worse. He also pointed out that payroll growth has plunged by 63 percent … that household confidence in future income remains low … and that business spending is waning.
Meanwhile, several other commentators are getting even more negative:
* The International Monetary Fund just cut its global growth forecast for 2013, citing Europe’s downturn and the slowdown in emerging markets.
* Goldman Sachs just slashed its U.S. GDP growth forecast for the second quarter to 1.1 percent from 1.3 percent, not very far from stall speed.
* Pimco’s “Bond King” Bill Gross just said the U.S. is “approaching recession when measured by employment, retail sales, investment, and corporate profits.”
* And a leading economist at the prestigious Economic Cycle Research Institute, Lakshman Achuthan, just said never mind what hyperactive stock traders say on CNBC. We’re already in a contraction!
… and What Bernanke Can’t Do about It
That’s a seriously broad-based indictment of the economic environment, with little reason to expect a turnaround any time soon. Yet stock traders have tried to ignore that fact, figuring Bernanke is in their back pocket.
|This week, Fed Chairman Bernanke offered Congress his grim assessment of the U.S. economy.|
But let’s take a look at the remaining Fed “tools” Bernanke cited in oral and written testimony this week …
First, he said policymakers could cut the interest rate paid on excess reserves (IOER) the banks hold at the Fed. The idea is that doing so would prompt banks to lend out their reserve funds rather than just park them at the Fed for a few nickels and dimes.
The problem? The IOER is already a rock-bottom 0.25 percent. Cutting it by a few basis points to 0 percent will have practically no impact on the willingness of banks to lend. If anything, it could HURT the economy by driving money market funds out of business, draining a vital source of savings for economic expansion!
Second, he said the Fed could use “communications” tools to guide market expectations. That’s Fed jargon for promising to keep rates lower for longer than the current “at least through late 2014″ pledge.
But the fact is, nobody expects the Fed to do anything with the federal funds rate anyway! Plus, the Fed’s long-term projections have proven wrong so many times that a promise to hold rates low through 2015 … 2016 … or 2040 for that matter isn’t worth the paper it’s printed on. So that kind of move won’t help at all.
Third, Bernanke said the Fed could consider another round of quantitative easing, or QE. This seems to be the bulls’ biggest hope of all. They’re all assuming that as soon as Bernanke pulls the trigger, the stock market will be off to the races.
Look, QE1 came at a time when the lending rates were very high and the credit markets were in complete disarray. It was a brand new policy nobody expected, and it had a huge impact in terms of bringing down spreads, rates, and risk levels.
But QE2 was less effective in terms of impact because market dysfunction was already largely fixed and because the underlying economy was weakening. Moreover, other similar programs from the European Central Bank’s LTRO1 and LTRO2 to Operation Twist 1 and 2, have had even less of an impact than QE2!
Just consider: A Credit Suisse note from a few days ago chronicled the findings of several studies on the impact of QE on 10-year Treasury Note yields. Several researchers estimated QE1 lowered yields by around 90 basis points to 100 basis points. But they also concluded that QE2 moved rates by as little as 13 basis points!
That was the supposed impact on the financial markets. The impact of several hundred billion dollars worth of QE on the real economy — meaning GDP — was as paltry as 40 basis points. That’s the difference between 0 percent growth and 0.4 percent growth, a drop in the bucket!
Yet somehow we’re supposed to believe that QE3 — the THIRD iteration of a policy that’s having less and less impact on financial markets, not to mention a near-zero impact on the real economy — will somehow be different?
Is there anyone on the planet who really believes that 3.56 percent 30-year mortgage rates — the lowest in the history of the United States — are holding back the housing market?
Or that 1.45 percent 10-year Treasury Note Yields — also the lowest in history — are hindering the broad economy?
Even IF QE3 succeeded in lowering yields by another 10 or 20 basis points, can anyone seriously argue with a straight face that it will make a major difference on the financial markets or economic outlook?
I think those are bad bets to make. And that’s why I continue to remain cautious on most stocks and asset classes!
Until next time,