Addiction of Duplicities

Addiction of Duplicities

By J.M. Hamilton 2-24-13 

Why does the stock market soar? 

To hear many a CEO or banker tell it, the economy, although improving, is still struggling.  Economic headwinds from across the pond are not good.  The uncertainty produced by a highly dysfunctional federal government has shuttered CAPEX and R&D, and so many corporations are sitting on mountains of cash.  The consumer is still mired in debt, upside down on their mortgages, or reluctant to spend, as the baby boom generation begins to retire, those with the means that is.  Job creation is still too few in number to bring down intransigent unemployment and underemployment.  And, as reported by Bloomberg this week, bank lending is at a five year low.  Wall Street banks have turned into giant hedge funds, speculating while borrowing at the Feds window.  The malaise feeds on itself.

Dems are fretting over what the sequester will do to the economy.  This is what happens when too many eggs are placed in too few economic baskets… that is, the U.S. has grown dependent upon too few industries (the financial sector, defense spending, government spending, agri-business, big oil and healthcare), and now pines for the return of manufacturing. When one of these sectors sneeze, or the government desires to spend less, the economy catches a cold; and of course, home building although showing some green shoots, remains in the cellar.

So if the fundamentals are lousy, the question gets asked again, why does the stock market soar?

The short answer is the Federal Reserve or Fed.  The Fed has been printing some eighty odd billion a month to purchase T-bills and MBS, and the reasons for this are as multivariate as a rose.  Among them: Fed purchases and balance sheet expansion keeps interest rates suppressed and allows the Wall Street banks and shadow banking to jack up the stock market to new heights (or what this blog has referred to as trickle down monetary policy); it keeps the interest on the national debt low, so that Washington can continue to live beyond its means; it keeps all those adjustable rate mortgages the banks like to sell Americans from being foreclosed upon; it allows the U.S. to export the few products it manufactures overseas at a discount (in the classic “beggar thy neighbor” approach); and of course, there are all those hundreds of billions (notional value) in credit default swaps that are betting on continued Fed interest rate suppression.

Many economist will tell you that the Fed plays a not insignificant role in the boom and bust cycles this country goes through, with greater rapidity and frequency.  The stock market is now so addicted to easy money and short-term speculation, instead of long term investment and sound business fundamentals, that when the Fed talks of pulling away from its purchases or yanking the punch bowl, the Street begins to jones.

Meanwhile, M&A activity and private equity deals appear to be heating up, which tells me that we are on the cusp of yet another bubble (observe the LBO of Heinz).  M&A is great for the banks and the financial elite, but presents a problem for employment prospects, as it invariably leads to synergy and pink slips to help pay for all that debt.

So little has changed since the last crisis, which one can argue we are still in the midst of; Dodd Frank has yet to be finalized, and derivatives and swaps regulation has still not been enacted.  And Basel III has been punted down the road.  The herd is now buying back into the stock market, while the heavy hitters are taking their money off the table.

In short, look for the Fed with no good options to keep its foot firmly mashed on the printing press accelerator, and lookout for the possibility of what PIMCO’s Bill Gross recently called a financial supernova.

 Copyright JM Hamilton Publishing 2013