Equities in a sweet rut
By James Saft
(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.
(James Saft is a Reuters columnist. The opinions expressed are his own) (At the time of publication, Reuters columnist 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. For previous columns by James Saft, click on)