After the central bankers met at the annual Jackson Hole Symposium last month, it appeared that the deciders passed the QE torch to the ECB as the European economy stagnates more than others. It is a close race because both China and Japan are clearly in quite a soft spot. We are glad money printing is set to end next month in the U.S., but with August’s employment report showing the slowest job growth of the year and more labor force shrinkage, the timing of the cessation of what the Fed perceives as stimulus seems illogical by the central planners’ way of thinking. Industrial production actually declined in the U.S. in August, in a continued sharp contrast to all those rosy soft data surveys like the ISM that are often trumpeted. In addition, trade sanctions over the Russian invasion of the Ukraine, turmoil in the Middle East, and Scotland’s vote for independence all add up to a big list of items to add to volatility, but you would never know it if you just follow the stock indices.
Responding to signs of economic weakness, global bond markets continued their huge rally into the final innings of summer last month in an apparent contradiction to equity index strength. That divergence can be explained by the notion that some devout equity players expect monetary policy to remain quite easy after QE stops in the U.S. without sensible regard for what such implied weak growth might mean for future earnings. It is also important to keep in mind that the average stock is lagging the major indices in a big way and the S&P 500 owes a lot of its levitation to the recession-proof utilities and healthcare sectors this year. According to a recent Bloomberg piece, “about 47 percent of stocks in the Nasdaq Composite are down at least 20 percent from their peak in the last 12 months while more than 40 percent have fallen that much in the Russell 2000 Index.” We doubt the holders of those losing positions will get any compensation from the Fed for their allegiance to the QE siren call. Many commodities are in full retreat to multi-year lows as well in another sign that the deciders are losing their asset reflation fight.
Perhaps markets recognize that it is getting quite difficult for the ruling elite to concoct additional market pleasing measures. Words are beginning to sound more hollow, even to some of the staunchest QE supporters. Policy makers have created another big mess like 1929, 1999, and 2007 and many of us know that. Central bankers are tripping over each other to implement policies and dominating market activity. For instance, the Fed’s massive bond buying has made it quite difficult for traders to locate treasuries to use as collateral and that has made leveraging strategies more difficult and otherwise clogged the system.
Importantly, central banks in other countries need to buy our treasuries as well to execute their currency debasement plans, but the Fed gets in the way. At the same time, trading in Japanese bonds has become moribund because the Bank of Japan has crowded out traditional participants with its buying. In Europe, the ECB is trying to grow a relatively small asset- backed bond market just so it has fodder for QE since Germany does not want it buying sovereign debt.
The reality is that most consumption that is not being driven by a new lending scheme like 84-month auto loans and subprime lending looks quite weak. We could bore you with a complete list, but suffice it to say that over the last month we witnessed quite a weak earnings reporting period for retailers and restaurants. It is even more stunning compared to the common rhetoric that the Fed must soon begin raising rates because growth is strong. Our large group of disappointing names in these sectors, which speak volumes about actual economic activity, could best be summarized as quasi-recessionary in its breadth. From teen clothing and office supply merchants to big department stores and quick service restaurants, it is hard to find pockets of strength. Many major retailers continue to close large numbers of underperforming stores and we are not just talking about Radio Shack and Sears. “Clearly the rebound that we were all expecting in this year hasn’t happened. So the consumer has not bounced back with the confidence that we were all looking for,” said Terry Lundgren, chief executive of Macy’s Inc., in discussing recent trends.
Key market metrics that we follow (price/revenue, market cap/GDP) remain at over twice historically normal levels, making it tough to find value. With the median stock never more expensive and many investors willing to bet that record margins will get more “recorder,” U.S. equities are priced for perfection. That makes for a risky environment that rivals the other major bubble periods when investors also seemed to decide that they had come up with a new reason to ignore math. We will not ignore the math.
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.