The Fed Feeds the Bull

Posted on April 7, 2013

7


When the Fed pumps the Dow jumps.

A lot of people are puzzled by the strange disconnect between the behavior of investors in the stock market and the underlying fundamentals of the economy.   Psychologists call this ‘dissonance’, which is an expensive word to describe the feeling that what I’m seeing doesn’t make sense.  You’ve been seeing the Dow Jones Industrial Average, the Standard and Poor’s 500 and other indices pushing higher and higher ever since the re-election of Barack Obama to the White House.

People question the irrational exuberance that is on display, when in truth, there doesn’t seem to be anything to suggest that the markets should be surging as they are.  Let’s look at a few basic data points that make a bull market, look precisely like, well – ‘bull’. First, the economy is stuck in a slow growth mode.  The GDP of the world’s biggest economy shrank for the first time in three and a half years during the fourth quarter, dropping at an annual rate of 0.1%, the commerce department said.  It was the US’s worst economic performance since October 2009, and came as economists had been expecting mild growth of about 1%.

The price to earnings ratios of the equities comprising the stock indexes don’t support a ballooning of values.  The Economist recently noted, “It is tempting to attribute the strength of the Dow to optimism about the American economy. Tempting, but wrong. Studies have shown almost no correlation between GDP growth and equity returns…this rally in the Dow has been accompanied by the weakest GDP growth of all the bull markets since the Second World War.”

Some media reports have attributed things like enhanced job reports, housing numbers and apparent resolutions to the European economic crisis’s as explanations for the robust upswing in the markets.  We’ll look at the fallacies behind those notions in a moment, but still, the S&P500 and the Dow Jones just keep hitting ‘historic’ highs.  What’s really going on?

Are there just a lot of Obama ‘haters’ on the Right, wishing ill of him, his presidency and of the Democrats?  Is that what accounts for the dire predictions of doom for the economy and the lack of enthusiasm among conservatives, for all the glittery economic news churning forth from the MSM?  Is Keynesian economics being validated before our disbelieving eyes?

There is a rational exegesis available for the incongruous state of affairs.  The main resolution to the dilemma before us is to be found in the activities of the Federal Reserve.  As is well known to most of my readers, the general population of citizens and voters haven’t a clue as to what the Federal Reserve is and how it impacts the economy and their daily lives.  They certainly don’t know that the glib explanations of the corporate political media, referencing improved employment numbers and supposed growth in housing, have nothing to do with the bull run on the Stock exchanges – but rather are attributable to actions of the Fed.

The Fed has been buying, with newly printed money – $85 Billion dollars in Treasury securities every month since the beginning of ‘QE3’.  NPR’s Planet Money gives a good layman’s explanation of the effect of this:

“A big bank — Bank of America, say — has $50 billion in government bonds. They’d sell those bonds if anyone would pay enough for them, but nobody is willing to pay that much.  So the bank just holds on to them. With quantitative easing, the Fed comes along and says, ‘Hey, Bank of America, we’ll buy those bonds for a little more than anyone else is willing to pay.’  Bank of America says, ‘OK, great, send us the money.’

This is where the Fed gets to use central-bank magic. They pay for that $50 billion purchase in new money. They just invent it. That’s what the Fed — but nobody else — gets to do.  So now Bank of America has $50 billion they need to do something with. The Fed is hoping that Bank of America will decide to lend that $50 billion to companies and people to invest or spend.  That stimulates the whole economy.”

But these banks and other investment firms that sell the government bonds back to the Fed, don’t put all that money back into the credit market.  They pump it into equities.  If $85 Billion dollars rolls over into the stock markets on a monthly basis, what do you suppose is going to be the effect? This new fiat currency is pure inflation, an increase in the money supply that is injected into the economy the moment the bond issuer spends it. The market climbs and climbs, irrespective of all of the other factors in the economy that would ordinarily mitigate against such a run up of the Dow and the other indices.  Adam Hamilton of Zeal Investments characterizes the resulting effect:

“Overall, the correlation between the US stock markets and the Fed’s monetization is very tight and rather remarkable.  When the Fed is creating new money out of thin air, it is only natural that some of it would find its way into the stock markets.  And provocatively, whenever the Fed slowed the growth of its balance sheet or backed off on Treasury purchases, the stock markets promptly pulled back or corrected.”

Here is a chart that illustrates the correlation between the Fed stimulants and the upward trends of the markets.

The Fed Stimulus and the Wall Street Bull Market riding the same wave.

But wait a minute, our liberal and Center – Left friends say, “what about the jobs numbers?  Unemployment is down – we must be in a recovery and that’s why the stocks are climbing”.  What about the jobs numbers indeed?  Is unemployment really down?  Is consumer sentiment really up?  The answer to both is no.  We’re being fed fallacious statistics and numbers.  Let’s talk about unemployment for a moment. There is this inconvenient little detail called the ‘Labor Force Participation Rate’ that is included in the Labor Department’s Jobs reports, but not highlighted or emphasized – in fact it’s difficult to locate.

There’s a reason.  When the economy is actually improving and jobs are being created, the LFPR (Labor Force Participation Rate) goes up.  When there is a ‘faux recovery’ or sometimes referred to as ‘jobless recovery’, the LFPR goes down. The LFPR is more relevant and more revealing than the Unemployment numbers.  Here’s the nuance.  When the Unemployment rate goes from 7.7 to 7.6, this does not indicate that more unemployed individuals re-entered the workforce; it means instead, that more unemployed individuals are no longer registered in the government system, applying for and collecting benefits.

Again, this is something that the average poorly informed citizen (and voter) has almost zero comprehension of. Why?  Well, because they aren’t being educated by the people who disseminate the so-called ‘news’ and because they are willfully distracted by the ‘Bread and Circuses’.  Just to shed some perspective on the reality of the jobs picture, the LFPR stood at 63.8 in July 2012 – a near 30 year low!

Certainly if we’re in a recovery and Obama and the Democrats in concert with the Fed have turned things around, the LFPR should be going up, right?   Guess what?  It’s going down.  Just today, here in April 2013, the LFPR is now at 63.3.  It’s trending down, not up – significantly in fact.  The LFPR was 63.5 in February, so in just over a month, the number of people participating in the Labor Force has dropped 2/10ths of a percentage point.  Consider the numbers:

  • The number of persons employed part time for economic reasons (sometimes referred

to as involuntary part-time workers), fell to 7.6 million from 8.1 million.

  • In March, the number of long-term unemployed, (those jobless for 27 weeks or more),

was little changed at 4.6 million.

  • In March, 2.3 million persons were marginally attached to the labor force, essentially

unchanged from a year earlier. (The Data are not seasonally adjusted). These individuals

were not in the labor force, wanted and were available for work, and had looked for a job

sometime in the prior 12 months. They were not counted as unemployed because they

had not searched for work in the 4 weeks preceding the survey.

  • 803,000 discouraged workers in March, little changed from a year earlier.
  • Total underemployed – 23.2 million.
  • Unemployed – 11.7 million.

Considering the fact that the surveys that the Bureau of Labor Statistics uses to arrive at these numbers, are not scientific and vulnerable to a great deal of distortion and manipulation, the real jobs picture is likely to be much uglier than even what the media is regurgitating.  So, if any investors are claiming that they are doubling down on stocks because of the jobs picture, all they are really doing is doubling down on stupid.

What’s left?   The Europe Debt crisis in Spain, Greece, Cyprus, Portugal, Ireland and elsewhere, is stabilizing?  No, nothing has been solved there.  The situation is analogous to the short term band-aids applied by Congress and the White House here, in response to the ‘fiscal cliff’ and the overwhelming debt.  In Great Britain, it was just reported that for the first time national debt is 90% of GDP!  That’s staggering.  So can it be said that something miraculous has occurred to transform the economic situation in Europe?  No.

Then we hear that it is the housing market that is responsible for the illogical enthusiasm of Wall Street investors.  That brings us to another general symptom of the Fed’s Quantitative Easing (QE) – inflation.  It is a relatively direct consequence of dumping enormous sums of money into the economy that are not tethered to actual economic growth.  In times of rationality, the money supply is increased on the basis of productivity and growth in the economy.  That’s not what’s happening now.  Economic growth is stale and anemic.  For the fourth quarter of 2012, the growth rate of U.S. GDP (Gross Domestic Product) was an eye popping 0.4. Annual growth has been at under 2 percent on average, since the recession started.  The Associated Press outlined it thusly:

“The economy grew faster last quarter because consumer spending rose at a 2 percent annual rate, up from a 1.5 percent rate in the second quarter.  Spending on homebuilding and renovations increased at an annual rate of more than 14 percent.  And federal spending surged, mainly because of the sharpest increase in defense spending in more than three years.  Growth was held back by the first drop in exports in more than three years and flat business investment in equipment and software.”

A couple of observations regarding this.  One, you’ll notice that there was a sharp increase in Defense spending.  Interesting isn’t it, that defense spending is ramped up significantly and then just a few months later, the poor performance in the economic numbers is blamed by Democrats and partisan pundits, on ‘the Sequester’?  Additionally, inflation is so much worse than the government and the media are reporting, that the media outlets should be sued for malpractice.  Have you been noticing how much it costs to fill up your gas tank?  Meat, bread, breakfast cereal, commodities, daily necessities – they’ve all been rising dramatically.  Does any person who is not entirely gullible think that their cost of living has only risen 1.7 percent?

There is no ‘increase in consumer confidence’ (unless they are only polling idiots), people are just more and more, living beyond their means because of the hidden tax of real inflation.  So, in fact, the balloons that are re-inflating in the housing markets and elsewhere are not attributable to growth in personal income – because we know that has remained stagnant, and in many cases household income has even gone down.  I’ll grant you that if the corporate media were presenting the real economic picture of this country, including how our trade imbalance is growing, the American consumer might not be making a lot of imprudent and unnecessary purchases on non-durable goods (translate – ephemeral garbage) that they are.

Here’s an observation on the seemingly bizarre disconnect between stocks and the real economy from Lakshman Achuthan, co-founder of Economic Cycle Research Institute (ECRI):

“But of course, there is the elephant in the room, the impressive upturn in stock prices. How can we possibly be in a recession if the stock market is doing so well?” asks Achuthan.  “It is important to remember that the stock market is not the economy and the economy is not the stock market.”

Achuthan wants people to know that “cycles in economic growth and stock prices do not always move together.  It is true that 80 percent of the past 15 recessions has associated equity bear markets, but in three of those 15 recessions there were not cyclical downturns in stock prices.  Specifically, this happened in 1980, 1945 and 1926-1927.”

So, what’s the differentiation here?  The pumping of Federal Reserve.  Bernanke openly admits it, even if the MSM doesn’t bother to point it out. “We do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery…” But how much has the Fed pumped in, not counting the bailouts? As of 2012, the Fed, through the completion of QE2, had purchased $2.8 Trillion of government bonds and mortgage backed securities (Fannie and Freddie junk). By the end of this year, their total monetary infusion will be over $3 Trillion.

The world’s ‘Big Four’ Central Banks, U.S. Federal Reserve, European Central Bank, Bank of England and Bank of Japan have collectively pumped $6 Trillion dollars, with scant tangible results other than in the case of America, the equities markets have recovered.

As Reuters describes it “electronic money creation to date – whether directly through bond buying in the United States or Britain or in a more oblique form of cheap long-term lending by the ECB – is not even replacing what commercial banks are removing by shoring up their own balance sheets and winding down loan books”. No trickle down effects are being felt by the unemployed or underemployed or in family incomes. But the 1 percenters have been made whole, thanks to American taxpayers and future generations who will be saddled with the debt.

At some point in the future, the end of the Quantitative Easing cycle will arrive – mainly because it is unsustainable. It is then, when there is no longer an infusion of $85 Billion dollars a month of money printed on the basis of no real, objectively measured economic value or growth, that the capital flows to the markets will reflect reality.

The greedy and foolish ignoramuses that don’t understand the dynamics of this situation, will be caught with their tails in a crack. The reality will be a grim one. When that happens, there might be a little buyer’s remorse over that 55 inch LED Flat Screen TV you could have lived without. The writing is on the wall. Ignore it to your own peril.

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