The Corner We Have Been Forced Into


By Michael Lombardi, MBA for Profit Confidential

Boy, has the Federal Reserve ever created a monster with its monetary policy of creating $85.0 billion a month in new money out of thin air!
Consumer confidence is anemic in the U.S. economy as Americans are being financially “squeezed.” Consumer confidence, which is missing in this so-called economic recovery, leads to higher consumer spending, which makes up two-thirds of gross domestic product (GDP) in the U.S. economy.
Two days ago, we got news the Conference Board Consumer Confidence Index declined to 80.3 in July, down about 2.2% from June. (Source: The Conference Board, July 30, 2013.) This is nowhere close to the consumer confidence levels we saw prior to the financial crisis in the U.S. economy.
The survey of consumer confidence in July showed 35.5% of respondents are claiming jobs are difficult to get.
But that isn’t all…
We are told the housing market is improving, but few mention that millions of Americans are living in homes they purchased with positive equity that now have negative equity—their home prices are lower than the mortgage they borrowed on them. The number stood at 9.7 million homes with negative equity at the end of the first quarter. (Source: CoreLogic, June 12, 2013.) This phenomenon breeds consumer discouragement, not consumer confidence.
All of this is not a surprise to me; I have been saying it all along. Consumer confidence cannot improve because the Federal Reserve is buying $85.0 billion a month of U.S. Treasuries and mortgage-back securities—none of which helps the “little guy.”
Look at Japan, a country that has become famously known for its monetary policy and quantitative easing. One would assume that after all these years of the Central Bank of Japan printing new money (their debt-to-GDP multiple is 205%), consumer confidence and economic growth in that country are both rising.
But money printing didn’t help the Japanese economy or its consumer confidence. In June, industrial production in the Japanese economy fell 3.3% from the month earlier—the first decline in five months! (Source: Reuters, July 29, 2013.) The Japanese central bank is failing, and we should learn from its experience, not follow in its footsteps.
Our Fed’s monetary policy has fueled a stock market rally that will implode once the Fed turns off the “money tap,” further hampering already weak U.S. consumer confidence.
As my colleague Anthony Jasansky, P. Eng., so eloquently wrote yesterday about the Fed’s “flip-flop” on scaling back the actions of its printing presses:
“A stock market sell-off of less than 8% was enough for the Fed to back-off from their plans to end the ongoing monthly $85.0 billion bond purchases. As this ‘innovative’ version of quantitative easing (QE) has no specific termination date, I have named it ‘QE Open.’
Like the two previous versions of QE, the Fed’s latest money pumping program has benefited the financial markets more than the real economy. With Ben Bernanke quickly reversing plans to end bond purchases, the U.S. stock market rapidly recovered with the majority of indices making either all-time highs, or multi-year highs.
One useful lesson investors have learnt from the market’s reaction to the Fed’s flip-flopping is that shutting down of its money pump will be damaging to stocks and even more so to the bond market.”
Consumers and investors have been forced into a corner where QE keeps pushing stock prices higher, but doesn’t really help the average consumer who the economy needs so desperately to spend.
The Fed cannot turn off the “money tap” because it doesn’t want to see the stock market collapse, and it will take away from the support it currently gives to the U.S. Treasury market.
Now, let’s see how this all affects the stock market in this story…
Michael’s Personal Notes:
We’re halfway through the second quarter’s earnings reporting season and, as I expected, it’s not turning out to be as good as what optimistic advisors were expecting. Corporate earnings for the S&P 500 companies are anemic, and their prospects of growth in the current quarter have already started to diminish.
Sure, it’s common these days to hear S&P 500 companies are beating corporate earnings expectations. In fact, as of July 26, 263 of the S&P 500 companies had issued their quarterly corporate earnings, and 73% of them beat expectations. (Source: FactSet, July 26, 2013.)
Sounds great—until we take a closer look.
Companies beating expectations aren’t what they appear to be. What they are “beating” are analyst expectations that have already been lowered. As a matter of fact, the corporate earnings “surprise” factor (the percentage of companies reporting well above expectations) is only 3.2% so far—far below the average for the last four years.
As for the revenues of the S&P 500 companies, we have seen a growing trend of companies reporting revenues well below expectations. For the second quarter, so far, only half of the S&P 500 companies that have rang in their corporate earnings registered revenues that were above expectations.
And we have the S&P 500 companies issuing warnings about their corporate earnings for the current quarter.
So far, 43 of the big S&P 500 companies have issued negative warnings about their third-quarter corporate earnings, while only 11% provided positive guidance.
Add in the stock buyback stories I have been writing about in these pages, and corporate earnings for the second quarter are far from impressive. Looking at future earnings guidance keeps me pessimistic about the corporate earnings growth rate going forward.
How long can the stock market continue rising if corporations are struggling for income and revenue growth? The markets can stay irrational for a long period of time, and they will continue to rise irrationally until: 1) the Fed reduces the amount of new money it creates each month; or 2) consumers pull back on spending as the economy erodes. We are likely to see the latter scenario before the first, as consumer spending is getting softer with each passing day.
The U.S. economy is in a “no-growth” stage. It’s growing at a rate of only 1.7% per year, according to a report yesterday from the U.S. Department of Commerce (a figure I expect to be revised downward in the weeks ahead).
With the Commerce Department’s gross domestic product (GDP) numbers yesterday, we discover consumer spending has dropped 22% from the first quarter of 2013 to the second quarter of 2013. How can corporate earnings rise in such an environment? They can’t, and that’s why the stock market’s advance (minus the Fed’s $85.0-billion-a-month printing program) is a farce.


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