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March 2013
Don't worry, be happy! (But keep an eye on the Fed...)
So far this year the markets have bucked conventional wisdom, ignoring the budget sequester in Washington and setting record new highs for the Dow. The message from Wall Street appears to be that it likes less spending and slightly higher taxes, if it helps reduce the federal budget deficit. What's fueling this Alfred E. Neuman "What, me worry?" stock market rally? Primarily three things: the economy, the Fed and plain old greed.
The economy is showing signs of strength, led by the housing industry. Existing home sales rose 0.4% in January to a seasonally adjusted annual rate of 4.9 million units, the second highest rate of sales since November 2009. That left the supply of homes for sale at its lowest level in 13 years, down 25% during the past year. Not surprisingly, the median price for a home resale was up 12% from a year earlier. Sales of new homes rose 16% in January to their highest level in 4 1/2 years. In fact, at the current sales pace, the supply of new homes for sale would be exhausted in four months, the shortest period of time in eight years. Mortgage defaults in January were 28% lower than a year earlier and new foreclosure filings reached their lowest level since June 2006.
The American Trucking Association reported in February that tonnage on the road surged 2.4% every month since November, gaining a total of 9.1% during the period. As a result, their For-Hire Truck Tonnage Index reached its highest level on record in January. Bank lending rose 1.7% last quarter, which was the sixth rise in seven quarters. And the construction industry reported adding almost 150,000 jobs since September, its best stretch since 2006, before the housing market collapsed. The Consumer Confidence Index moved sharply higher to 69.6 in February from 58.4 the previous month and non-farm payrolls rose more than expected, up 236,000 in February (though 102,000 of the job gains came from a statistical adjustment that the Bureau of Labor Statistics makes).
Everyone is bullish and positive on the market and the economy. That's when it's time to be careful.
About the only bad news out there was an ominous sounding email intercepted from a mid-level Wal-Mart executive reporting that February's sales were a "total disaster" - the weakest month he'd seen in his seven years with the company. Something definitely worth watching to make sure the impact of higher Social Security taxes and the spending cuts attributable to the government sequester don't pare back GDP by more than the expected 1/2 of 1%.
The Fed's actions are also contributing to the market euphoria. The Federal Reserve is still printing $85 billion each month to stimulate the economy and at least some of that excess liquidity is going into stocks, in addition to keeping interest rates artificially low. It is interesting to note that during the past three years, the Fed has purchased 80% of the new debt issued by the U.S. government. Remember when China used to be the largest lender to Uncle Sam? Well, not any more. Now the #1 lender to the U.S. government is the Fed. That's right - the U.S. government is the biggest lender to the U.S. government. You can't do that for too long without significant ramifications - as the Germans discovered when they attempted to pay for reparations after WWI by printing money.
Last, but not least, greed is fueling the market rally. Retail investors who wouldn't touch stocks when the Dow was at 6,000 have decided with the index at 14,000 it's a good time to buy equities. In fact, it's hard to find anyone who is cautious on the market outlook right now - typically a reason in itself for becoming a bit more cautious.
You can still borrow money to buy a home at 3.5% for 30 years. But, if the economy is getting stronger, then eventually the Fed will cut back or stop its quantitative easing program and interest rates will move higher. And then bonds with long and intermediate maturities will decline in value - big time. Makes you wonder just who is buying those bonds on the other end of the 15- and 30- year mortgages. I can assure you, it isn't our clients.
So enjoy the ride - but keep an eye on the Fed. Let's hope the economy gains sufficient momentum before the Fed decides it's time to leave the party and take the punch bowl with them.
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