The Fed did not reduce its monthly asset purchase amounts today at the conclusion of the FOMC meeting. While we had hoped to see a beginning to the end of QE and are surprised in some ways, it obviously fits with our theme that the economy is not doing nearly as well as the deciders were telling us. We wonder how much longer equity investors can hold out irrational hope in this crew to justify valuations, but we suspect that Mr. Bernanke has not helped his credibility.
We find it perverse that the Fed drives markets so completely.
In looking at the equity market on a price-to-sales or normalized earnings basis or other metrics, low single-digit future annual returns are currently priced into the market over the long haul. These are among the lowest historical projected return numbers going back a long time, QE or no QE.
While stocks are often considered the world of unlimited upside in bull markets, few discuss that long-term returns are determined by the initial price one pays for each dollar of earnings. Thanks to QE, 2013 has witnessed investors paying more and more for a flattening earnings stream in an economy that has disappointed to the downside and appears to be quasi-recessionary. At the same time, low quality stocks have been the big winner.
Bond bullish anecdotal comments and negative news from a plethora of sources are routinely and totally ignored…for now. The jobs report for August once again disappointed in a big way, but taper fear has held sway. Real final sales and consumer credit card usage have rolled over to the point that has signaled major trouble in the past. While auto sales for August were a perceived bright spot, some calendar quirks made comparisons a bit difficult. Plus, we know that an auto loan growth binge is driving this segment because incomes are going nowhere.
Retailers and restaurants remain in the doldrums based on an enormous number of company comments, but you would not know it by looking at most equities in the sector. FedEx just told us today that revenues grew a paltry 2% for its latest quarter and missed some estimates, but the stock is at all-time highs! Wall Street trading machines choose to focus instead on nebulous data like the numerous ISM surveys, which seem to move in the opposite direction from more dour management commentaries and actual revenue figures. The “Europe and China are turning up” story has received a lot of press of late mostly based on ISM surveys, but EU industrial production is reported to have fallen 1.5% for August, while Chinese export numbers are better only in comparison to very weak figures from prior months.
Nonetheless, a belief that the global economy must be strong because stocks are higher cannot be shaken. Last week we finally got a Time magazine cover (a powerful contra-indicator in market history) celebrating how wonderful life has been for investors (if you have been willing to tolerate the risk of a major loss of capital in an environment containing even more macro risk than that of 2008). The reality is that problem assets have been papered over (thank you FASB) and ignored for now as the Fed steers many to the edge of the cliff in a nauseating adherence to strategies which have resulted in three equity market bubbles and a housing bubble since the turn of the century.
While many point to the Fed-supported treasury market as manipulated, we posit that price discovery activity in equities is as phony as a three-dollar bill. We would not have believed five years ago that such high levels of illusory quoting would be considered legitimate behavior in any way, shape or form. Who needs the fabled but largely unproven “plunge protection team” when regulators have created a strange brew of exchanges, high frequency traders, and market makers that dominate activity, making true investment activity but a sideshow. Maybe our instincts are incorrect, but we cannot help but strongly believe that this chicanery will take center stage at some point when real selling happens. The late August three-hour trading halt brought to us by NASDAQ and other glitches like Monday’s snafu in options elevate this to “elephant in the room” status.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.