ICEBERG, RIGHT AHEAD
How clear do the warning signs need to be before investors wake up to reality? How much longer can we continue to justify rising asset prices? What new evidence will we bring to the table to affirm that justification? The “group-think” mentality has taken over financial markets and has prevented investors from seeing the bubbles that lay right before them.
A little more than 5 years ago the Fed embarked on a wild experiment that was meant to push the economy back to full output. QE was the first of its kind, and Ben Bernanke was hailed as the hero for having saved us from a depression. Well here we are, 5 years later, and what do we have to show for it all? Well on the one hand we have a stock market that has been setting record highs every few weeks,home prices that are on the rise, and an unemployment rate that’s now at 6.1%. Sounds like the good times are back again, right? Well, fundamentally speaking, the good times won’t last much longer because the underlying story is a lot different.
THE CONSUMER CAN’T SAVE US
Consumer spending has yet to pick up this year, even after all the harsh winter propaganda has worn off. The first two months of the second quarter showed that personal income expenditures are even lower than the first quarter and it’s not that Americans aren’t spending because of the weather, they’re not spending because they don’t have the money to. Personal income growth has remained stagnant since the crisis, labor force participation is at a 35 year low, and the U-6 unemployment rate is in double digit territory. Retailers like Walmart, Lumber Liquidators, Kroger, Container Store, and Family Dollar have all cited a “consumer funk” as the reason for lackluster revenue growth which isn’t really much of a surprise considering what we know about the consumer’s plight. More than 2/3’s of our economy is dependent on the consumer, but the consumer can’t afford to carry us to prosperity any longer.
WHAT THE FED DOES BEST: INFLATE ASSET PRICES
It’s obvious to me that there’s a bubble in equities that have been fueled by 2 things: Share buybacks and the search for yield. Over the past year, a record number of companies have been engaged in share repurchase programs. Share buybacks serve to return cash to shareholders, but they also serve to boost EPS with fewer shares outstanding, which ultimately lowers the P/E ratio for a company. Analysts and market economists continue to cite data which shows that the current P/E ratio isn’t too far above the historical average for the market, but I wonder if they considered the role of buybacks in their data gathering. While the buybacks have provided a false sense of security for current valuations, the bubble has gotten most it’s air from the Federal Reserve. The Fed has kept bonds yields far too low for far too long, and in doing so they’ve forced investors in search of yield to either move down in credit quality or to put their money into stocks. We’ve had a bond bubble ever since the Fed embarked on their rescue plan and it’s now clear that the bond bubble has helped to inflate the stock market bubble. It’s also no surprise that the Federal Reserve and Janet Yellen are completely oblivious to the fact that there is a bubble, let alone their role in creating it.
There will be no exit strategy for the Fed. QE will become the new normal because the Fed never stops to consider a recovery where they don’t play a role; they’ve got one play in their playbook and it’s all they know. As everyone forecasts 3-4% second quarter growth, I’m calling for negative GDP figures to come out, and when they do we’ll see the pullback that’s been long overdue.