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Inside the Market

3/7/2011

Despite a glimmer of hope on the unemployment front, there remains a very tricky and unstable underpinning to any good news regarding a rebounding economy.

OK…we’ll try not to be perpetual pessimists regarding the plight of an economic recovery (although considering realistic macro underpinnings, it’s tough not to be).  So the team will acknowledge the ok non-farm payrolls report last Friday along with some recent perky manufacturing data and auto sales activity.  HOWEVER, don’t get too pie in the sky just yet.  There remains a very unhealthy underpinning to any good data that may arise during this grinding, slow economic recovery.  And this unhealthiness refers to the use of Equity price appreciation as a vehicle to stimulate economic activity.

One may consider QE2 as merely a fixed income strategic initiative; however policy makers did allude to the focus of this initiative to promote the allocation of investment funds towards riskier assets.  Some of these assets include Stocks.  As we all are aware, since the announcement of QE2, the major stock indexes are up over 30% in much less than a one year period. Rising stocks increase the net worth of consumers and enable firms to raise capital more easily.  This in-turn has multiplier affects throughout the economy. The problem with this tactic of artificially pushing stock prices higher is that it creates a false growth scenario for the economy.

A rising stock market is generally a result of the expectations of improved profits and economic growth.  The scenario we are facing now however is that rising stocks are one of the major forces spurring growth, which is somewhat of a perverted relationship…and this is where the danger comes in.  This scenario introduces a vulnerability of economic growth and stability to exogenous events.  These events could include dramatic increases in the price of Oil, increases in inflation, or increases in interest rates.  Yes, recent economic data looks positive but short term rates remain zero and well into the negative real rate zone, a scenario which has helped create bubbles in the near past and resulted in economic turmoil.  Why isn’t the fed tightening despite increased inflation and economic growth??…and the answer is??? There’s a damn good chance stocks could retreat and this would cause major damage to an economy relying on stock price appreciation.

What’s the answer you ask?….let’s play that broken record yet again.  Reduce unemployment the old fashioned way…hire US workers.