News Column

Market needs fundamentals to keep rising

June 29, 2014

, ,



Another day, another record.

It's become a familiar, and alarming, theme on Wall Street.

With the Dow Jones industrial average in striking distance of 17,000, and the Standard & Poor's 500 index inching closer to 2,000, it's time to question whether this market is being supported by real economic fundamentals.

The short answer? It's not.

New data show the economy shrank by 2.9% in the first three months of the year, worse than previously thought. And while many would like to blame the weather (yes, it was bad) and look ahead to a better quarter, the reality remains that this is an economy stuck in an anemic recovery with few signs of improvement.

Durable goods orders fell 1% in the latest month, meaning consumers aren't spending on big-ticket items, such as refrigerators and washing machines. Retail spending is still weak, and while we may be creating some jobs (in excess of 200,000 in the past four months) the quality of those jobs is lacking.

Wage increases are still nearly non-existent, despite the Fed injecting cash into the system for five-plus years. Homes sales are on the mend, however much of that real estate buying originates from investors and overseas buyers. Not a good sign for Main Street USA.

In addition, higher oil prices, a weak labor-participation rate and continued regulatory overhang from Washington all threaten economic progress.

Luckily for Wall Street, we have the Fed. This is a market that's fueled almost entirely by our central bank. While some may argue that the Fed saved us from the depths of a great depression, I'd recommend we all remember the law of unintended consequences.

Though we avoided a sharp economic decline, having record low interest rates for five-plus years, combined with an unprecedented amount of quantitative easing (buying Treasuries to help drive interest rates lower and keep liquidity in the system) has done little to improve the lives of everyday Americans and instead, may be resulting in a big unintended consequence -- the creation of an asset bubble in both stocks and bonds.

Cheap money is pushing investors further out on the risk curve. With interest rates at record lows, investors searching for returns are forced into risky assets such as high-yield bonds and equities. Instead of making rational decisions based on real fundamental economic growth and strong earnings, the old mantra, "Don't fight the Fed," is the one investors are living by. That's called complacency, and there's a lot of it these days.

Cheap money also fuels corporate buybacks and corporate mergers, neither of which directly helps the economy, nor gets Americans back to work -- but it does help stock prices.

How do you create demand in a slow-growing economy?

Maybe, just maybe, some optimism from the Fed would help.

Consider this: If consumers and businesses believe interest rates will be the same next year as they are today, why should they borrow money and take on risk now? With Fed Chair Janet Yellen indicating that the Fed will continue its zero interest-rate policy for the foreseeable future, there's little incentive to borrow and spend today.

The good news is that messaging may begin to change. This past week, James Bullard, president of the St. Louis Federal Reserve Bank, told Bloomberg News that the economy is improving enough to handle an increase in short-term rates next year. If nothing else, the threat of rising rates can hopefully begin to spur a little demand.

Interest rates can't stay low forever. We saw this movie play out in 2008, when low rates helped fuel a housing bubble that nearly collapsed the system. The question now: Is this the sequel? If interest rates remain at zero and asset prices continue being bid up without resulting in fundamental economic improvement, this will be a movie no one wants to see.


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: USA Today


Story Tools






HispanicBusiness.com Facebook Linkedin Twitter RSS Feed Email Alerts & Newsletters