We’re Heading Towards Tough Times For Stocks

September 16, 2013
By Vlad Karpel

While Ben Bernanke and all other FOMC members prepare another meeting to decide the future of monetary policy, the range of economic data to digest is huge. This could be a good sign that suggests a mild economic recovery. However, this recovery will lack enough enthusiasm to support the “tapering” decision that the FED would like to present as a solution.

Although economic data points to an improvement since the peak of the crisis, Ben Bernanke is concerned with the consequences “tapering” its current QE program will have on the economy. As we already saw, Treasury yields are rising fast. From a bottom near 1.66 earlier in the year, a 10-year government bond is now yielding 2.94%. If the FED makes cuts on its current $85 billion/month asset purchase program, yields will continue to rise. This  may result in a situation that will undermine the current economic recovery. Presently, it isn’t in a strong enough position to cope with this kind of negative shock.

At the same time, the pace that the economic data is improving has not been coming at a pace that the FED is comfortable with. Understandably, they want security before ending their QE program. Jobs are being created, GDP is growing, but the number of people who are marginally attached to the workforce is growing rapidly. Many are living at or below the poverty threshold while financial assets rise highly above what the reality of the current economy is capable of supporting.

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Let’s examine the most important facts surrounding the year just elapsed since the FED started its latest round of quantitative easing:

  • · The unemployment rate recovered from 7.8pc to 7.3pc during the last 12 months. With the FED spending almost $1 trillion per year in asset purchases, it seems something is failing here. Low interest rates should have driven investment higher and thus reduced the unemployment rate by a much higher percentage than it did. In fact, after $3 trillion was spent in asset purchases, the Fed couldn’t induce a recovery to the 5.0% unemployment rate that we are experiencing at the end of 2007.
  • · The latest GDP growth rates show a headline number of 2.5% for 2013. In the previous quarter the number was 1.1pc, and a sluggish 0.1pc in the prior quarter. This is not the kind of growth Bernanke would like to see. In fact, GDP growth for the last 10 years has been occurring at a 1.8% annual pace.
  • · Nonfarm payrolls have been rising at a pace of 183,000 per month during the last twelve months. It is insufficient to drive the unemployment rates substantially lower. At this pace, it may take more than 10 years to return back to pre-crisis levels.
  • · U6 is an alternative measure that takes people who are marginally attached to the workforce and those who are involuntarily working only part-time into account. If we look at these numbers instead of the straight unemployment rate, the number grows from 7.3pc to 13.7pc.
  • · When examining the latest numbers for the Supplemental Nutrition Assistance Program (SNAP), known popularly as the “foodstamp” program, it is found that that 47,760,000 Americans are currently participating in it. These citizens are in need of support for living at or below the poverty line. This corresponds to 15% of Americans. Unemployment has begun recovering. It was able to double since 2007 to slightly below 50% of pre-crisis levels. However, the amount of Americans receiving aid from the SNAP program has never stopped rising. In fact, participation in the “foodstamp” program has almost doubled since 2007.

 QE edit

These are just some of the numbers that will weigh on Bernanke’s mind during the upcoming week. He will have a tough call to make, as it is almost certain that the U.S. economy won’t have the means to survive from the inevitable withdrawal symptoms derived from QE absence. Simultaneously, mainstream numbers show that it may be time to cut on some select measures. This will allow us to save some fireworks in case they’re needed later.

As for the stock market, the near future isn’t bright. Investors should be cautious here. With Treasury yields already rising, their effect on the stock market is inevitable. Rising interest rates negatively affect company earnings, leading to negative changes in their market value. A correction will have to occur, sooner rather than later. This is especially important at a time when the S&P 500 is just a few percentage points below its record high, and 18% up YTD. Even if Bernanke decides to “not taper” next week, any upside for stocks will be limited. It will be very difficult for the FED to manage expectations for increasing interest rates, independently based on what Bernanke’s decision.

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