The recent developments surrounding the financial markets cause, at a minimum, mixed emotions. First, the good news – stocks are at record levels. Further, belief is quickly spreading that even higher prices lie ahead. Worries over the election, the fiscal cliff, and sequestration seem to be antiquated emotions of the good old days. More recent developments such as China, North Korea, and Cyprus are quickly dismissed as unimportant or, at worst, easily fixable.
The bad news is that stocks are at record levels – at the same time as interest rates are manipulated, debt is monetized, and currencies depreciated. Some argue that these artificial factors are the only reason for the market’s ascent. While they are not insignificant market influences, stimulus and easy monetary policies are not the lone reasons for the rally. Valuations are reasonable, profit margins are strong, earnings are growing and non-financial balance sheets are well positioned.
Whatever the reason behind it, stocks have had an incredible 2013 with the occasional selloffs being little more than one-day wonders. This steady levitation has resulted in the major averages, except the Nasdaq Composite, reaching new all time highs in the first quarter. This page from the tortoise’s playbook may have played a part in what seemed to be a generally subdued reaction to this market milestone.
While economic growth and corporate fundamentals have been important components driving equities, central bank policy has also played a key role. Our Federal Reserve with it many versions of QE (a fancy name for debt monetization) has been an active market manipulator for many years. Of course, among the gangs that can’t shoot straight, the European Central Bank (ECB) appears to be especially incompetent. Regulators and policy makers propose their final and ultimate bailout solutions on a monthly basis. Not to be left behind, the Bank of Japan has recently committed to fighting deflation by printing as much Yen as it takes. Given that the Land of the Rising Sun has been fighting deflation for over 20 years and conceding that creating currency with the press of a button is effortless, we wonder if “deflation” is still favored to win.
This renewed Japanese commitment is commonly referred to as “Abeonomics” as it is a key part of Prime Minister Shinzo Abe’s economic plan. It includes goals of helping domestic manufacturing through currency devaluation as well as motivating its citizens to move further out on the risk spectrum. In addition to buying the Nikkei, this can be done through selling the Yen and buying stocks with the newly purchased currency. Of course the U.S. dollar can be the recipient of this capital flow which then presumably finds its way into the stock market.
There is little doubt that the capital markets have welcomed this stepped up liquidity. Whether this ultimately increases GDP remains a question among some. However, central bankers and regulators strongly believe intervention and price manipulation are necessary steps to support the current system. As far as any associated risks, Chairman Bernanke repeatedly tells listeners that they are “manageable”.
“Once upon a time there lived a vain Emperor whose only worry in life was to dress in elegant clothes.”
That manipulation and intervention qualify as sound procedures troubles us. We are further disturbed by the widespread confidence that is seemingly placed in a group whose track record is far from spotless. This is largely the same cadre who were supposed to save us from the crisis that befell us. Everyone assumes, like Hans Christian Anderson’s emperor, the Fed , ECB, and BOJ are fully clothed. But the realization that they are naked is not part of today’s bids and offers. Perhaps there never comes a time when the markets see through this folly, but it won’t be pleasant if they do.
The incredulous need not look very far or hard to find catalysts. Some of the obvious include fiscal deficits without a semblance of a cure, a slowing China, and Europe without a fix. Cyprus bank depositors being included in the “bail in” is a new and alarming component to addressing a bank crisis. Furthermore, Italy can’t form a government. And how does one price the risk associated with North Korea?
Our worries are not a prediction for a stock market collapse. However, a painful correction would not surprise us. In addition to being a historic stretch without a pullback, we think there is too much complacency surrounding the economic landscape and global developments. If the markets continue their climb without an adjustment, there are always opportunities.
Past performance does not guarantee future results
Jeffrey J. Kerr is a registered representative of
LaSalle St. Securities, LLC, a registered broker/dealer.
Kerr Financial Group is not affiliated with
LaSalle St. Securities, LLC. Securities are offered
Only through LaSalle St. Securities, LLC
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