“Is the Market Defying Gravity?”
Ty J. Young Editorial
Many analysts remain surprised at how well the market has continued to perform despite significantly negative market events. It is seemingly defying gravity! The Dow and S&P 500 have recovered from staggering blows and continued upward through events such as: The Flash Crash, the Greek debt crisis, the Chinese intervention that drove our markets down last fall, and the most recent terror attacks in Paris and Brussels. We are now back to November 2014 levels, and we continue to enjoy a 7-year strong market upswing.
But nothing lasts forever. Trying to time the market is usually a losing bet, and a dangerous game to play with your investment money. You have to ask yourself simple questions that may not have simple answers: Why has the market rebounded from the declines in late 2015 and January 2016? And, is this a time to be cautious with your money?
I. Why is the market defying gravity?
1. Money has nowhere else to go. Where can you invest? Terror-stricken Europe? Militant China, with economic numbers you cannot trust? Russia? Some foreign stock exchanges may have appealing investment options, but in general, and in the world we live in today, money is safest in U.S. traded companies.
2. Market players are no longer afraid of interest rate hikes. Yes, there was an interest rate hike in December, and yes the markets declined. However, investors seem to have lost the fear that there will be several interest rate hikes this year, or if we get them, they will be significant in size. In fact, many believe we could see what is being tried in Europe and Japan – negative interest rates.
3. Economic indicators are steady. Employment – at least the way we measure employment – has been steady. Job creation – at least the way we measure job creation – has been steady. The bottom line is some of our leading economic indicators have been steady as compared to other global markets. This has kept U.S. stocks attractive.
II. Why you should be cautious, despite gravity defying market?
1. Markets have not grown since the money printing stopped. The market has seen wild swings up and down over the last year and a half – yet it remains in the same position as in November 2014. This was just a few months after the Fed officially withdrew its Quantitative Easing program (the printing of money) from supporting the market. The signal is clear – without QE, the market cannot advance.
2. Profits down in 3rd and 4th quarters. As Larry Kudlow often says: “Profits are the mother’s milk for stocks.” They are also a primary indicator for economic growth. Profits were strong during significant periods over the last 7 years, especially for large cap stocks, driven primarily by overseas sales. Foreign sales driving profit margins should have been a cause for concern. Now profits are drying up – down 5.1% (year-over-year) in the 3rd quarter for 2015, and 9.5% in the 4th quarter. Those are the largest percentage drops since the last quarter of 2008 – the height of the last financial crisis.
3. Economic growth has been anemic. As stated many times, economic growth during the last 7 years has been somewhere between non-existent to anemic. Even with every fiscal and monetary policy tool being used to its fullest extent, we still have been limited to an average of less than 2% growth. The 1% growth in the 4th quarter of 2015 only reinforces the notion that Main Street has been decoupled from Wall Street. This is cause for concern – markets cannot remain elevated when there is little underlying economic activity to support an elevated stock market.
4. Many predicting return of “stagflation.” Stagflation, defined as stagnant growth rates with rising inflation, is one of the most dreaded words of the 1970’s – and represents the utter failure of the liberal Democratic economic policies of the Jimmy Carter Presidency and took the Reagan Revolution to correct. Stagflation is making a comeback among leading policy circles in Washington and Wall Street. Inflation topped 13.5% for the year in 1980, and required a strong hand under Reagan’s Fed Chief Paul Volcker to bring it down. Many analysts were concerned with deflation just a few months ago, but they have now made a 180 degree turn on the issue. This shows a couple of things: A) Do these guys really know what is going on? B) Anyone living paycheck to paycheck knows inflation has been present despite the drop in gas prices (which has been helpful but seem to be heading back up). If you have not received a pay raise in years, then you know your cost of living is squeezing that paycheck.
Most people do not know the impact of the economic wizardry happening behind the scenes. Your 401K has benefited, but watch your wallets. The unprecedented market run over the last 7 years has defied the odds and defied gravity. But it has been an artificial creation through market interventions, TARP (the Troubled Asset Relief Program), Stimulus, Quantitative Easing (Rounds 1, 2 and 3), mortgage-backed security purchases, artificially low interest rates, zero-interest rate policy. Since 2009, these government moves have kept money flowing into the stock market – and that has been the primary driver of market gains. You may or may not be familiar with these terms, but they all enjoy the same characteristics: they are government actions intervening into the free market, and the evidence shows they have not stimulated the economy. These tried and true methods of prosperity have not been prominent in our economic policies: New business formation, lower taxes, job creation, new inventions, business start-ups, and innovation in the business marketplace. Instead, the stock market has been propped up by the government.
Without natural stock price appreciation, driven by growth and innovation in a free market, you will only see stagnation, inflation, and debt. In other words, the chickens always come home to roost, it is just a matter of when.
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