Equities in a sweet rut: James Saft

April 10, 2013

April 10 (Reuters) – The record-breaking rise of the stock
market is in part a function of the lousy jobs picture, which
ensures an ongoing prescription refill of Federal Reserve
medicine.

The S&P 500 index hit a record high on Wednesday, rising
more than 1 percent to as much as 1588. Since data showed on
Friday that the economy added just 88,000 jobs in March, the S&P
has added a cool 2.3 percent. And while the jobless rate fell
to 7.6 percent this was largely thanks to almost 500,000 people
falling out of the workforce, taking the labor force
participation rate to its lowest since 1978.

This state of play isn’t indefinitely sustainable, but there
is absolutely no contradiction between a spluttering economy and
a levitating stock market.

The Fed is boxed in – unless they see signs of a rapid
improvement in jobs, the debate they’ve been having among
themselves about tapering quantitative easing later this year is
going to be nothing more than a historical curiosity. And why
that rapid improvement should happen as the effects of
sequestration are felt through the year, I could not tell you.

It is likely that a strong jobs number would have actually
undermined equities, raising the prospect that complaints about
QE from those outside of Chairman Bernanke’s tightly knit
consensus would get a better hearing.

Minutes from the Federal Open Market Committee’s
rate-setting meeting in March, released on Wednesday, bear this
out. At the meeting, held before the jobs figures were
compiled, there was notable debate, with “a few” participants
wanting to bring the program to an end relatively soon and a few
others seeing quickly increasing risks and wanting tapering
“before too long.” Those views are probably more hawkish than
the consensus among those members who actually get to vote this
year, and also don’t seem to reflect the consensus at the
Bernanke-led core.

What seemed to get no hearing at all by the Fed were
alternatives to asset purchases which might work better. All of
the focus is on the risks and the rewards of QE, with consensus
coming down that the latter justify the former. The critics’
position is weakened by the fact that the un-enunciated
alternative amounts to admitting the limits of Fed power and
waiting to see what happens.

ROSY OUTLOOK, WEATHER TO REMAIN DREARY

That would be ugly if it happened, and precisely because of
this it won’t any time soon. The Fed will very likely continue
QE for the rest of this year, at least, and will try to plug the
dyke of doubt by making thoughtful and sober comments about how
it is working through mitigating the risks.

That leaves equities, if not job seekers, in a sweet spot.

Not only will money flow to riskier assets via the Fed’s own
QE program, the really quite large one recently announced by the
Bank of Japan will also help. Japanese institutions and savers
will doubtless flee the yen and the single-buyer Japanese
government bond market, with some of the money flowing to the
U.S., supporting asset prices here.

In the meantime, corporate profitability is helped by the
fact that there is a large core of highly employable people who
are seeing decent wage growth and whose assets, like houses and
stocks, are going up in value.

There are also signs of a nascent consumer credit loosening,
verging on a bubble, which will also support stocks, though
obviously not in a sustainable way. Reuters’ Carrick Mollenkamp
had a great report last week detailing the surge in subprime
auto loans, up 18 percent last year, and the Wall Street Journal
this week detailed a trend towards longer-term auto loans, of as
much as eight years. (here
here)

I could tell you about how it’s not a great idea to devote a
huge chunk of your take-home pay to a high-rate auto loan, or
for that matter of the questionable wisdom of financing a
rapidly depreciating asset with long-term debt, but that is all
beside the point. These loans are being made, officialdom seems
unlikely to interfere, in fact QE is a prime support, and for a
while at least, this will keep the merry-go-round spinning.

The main risks to equities, other than a worsening in
conditions in Asia or Europe, are all at what must seem a safe
distance. The Fed won’t pull back soon, and it will take a while
for the impact of sequestration to be felt.

This rally won’t go on forever, but, like the last two stock
market booms, will probably last longer and go further than it
merits.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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