This is getting to be monotonous, as for the fourth straight week, most of the major averages reached new all-time highs once again, as the Dow Jones Industrial Average, the S&P, the Russell 2000 Index of small stocks, the mid-cap indexes and the Dow Jones Transports all attained never-before-seen levels.
And in the process, little selloffs were met by renewed buying as if investors were looking for any sort of reason to keep the bullish juices flowing. Before a slight pullback on Monday, the S&P had gained for the 17th time in the past 21 sessions and there has not been a back-to-back two-day decline since April 17–18, which is astounding in and of itself. And in a refutation of the old market adage “sell in May and go away,” the S&P has now advanced by 4.4 percent so far this month, which compares to a 1.8 percent gain in the traditionally more friendly month of April.
As an example of how investors are throwing caution to the wind, when an economic report is released that comes up short of expectations, we see the old “bad news is good news” syndrome at work in the sense that if there are signs of a slowing economic recovery, this then means that the Federal Reserve and other central banks around the world will come to the rescue by continuing to provide record amounts of liquidity and by lowering interest rates to further all-time low levels. In fact, last week the central bank of Israel joined the Reserve Bank of Australia, the Bank of England, the E.C.B., the Bank of Japan and the U.S. Federal Reserve in either keeping or lowering rates to their lowest levels ever in order to provide the necessary liquidity to make it easier for both governments, businesses and individuals to borrow and invest.
With weaker economic releases such as April Industrial Production declining by the most in eight months, April housing starts declining by a large 16.5 percent to the lowest level since February 2011 and the May Philadelphia Fed Manufacturing Index falling for the first time in three months, investors cheered because this now meant that the Fed would continue to provide indefinitely $85 billion a month in stimulus through the purchase of both mortgage-backed and Treasury issues. On the other hand, when last Friday’s preliminary U. of Michigan Consumer Sentiment Survey rose to its highest level since July 2007 and the April Index of Leading Economic Indicators rose by the most in five years, investors then decided to push things even higher because now the thinking was that the economy is in good shape after all.
One of the reasons that the Federal Reserve is continuing to provide this liquidity is that despite the fears that this much money floating around the system is bound to lead to inflation and currency debasement, these worries have not come to pass as of yet, as both the April Producer Price and Consumer Price Indexes declined, the former to the lowest level since December 2010 while the latter showed the first back-to-back monthly decline since the dark days of late 2008 when the financial system was melting down and all asset prices were collapsing.
A recession in the E.U. and slower growth in China have undercut demand for U.S. exports, which has decreased some of the demand for our factory sector while the strengthening of the dollar against both the Euro and the Japanese yen has also led to a slower manufacturing pace in this country. In addition, the sequestration budget cuts in Washington, D.C. that took effect on March 1 to the tune of $85 billion in across-the-board spending reductions have also hurt.
A recent issue facing the markets is when will the Federal Reserve begin to cut back its current stimulus programs, as several top Fed officials have begun making noises to this effect. Stocks retreated last Thursday when the President of the Philadelphia Fed repeated his comments that the central bank should start to cut back on its stimulus programs as early as next month’s meeting. The selling was exacerbated when the San Francisco Fed President added that the Fed may begin to slow the pace of its $85 billion buying program amid signs that the economy is gradually gaining strength by saying that “it is clear that labor markets have improved since September” when the latest round of purchases began. He added that “we could reduce somewhat the pace of our securities purchases, perhaps as early as this summer” and end the program altogether late this year.
As if this was not enough, the chorus was joined by the President of the Dallas Fed who pointed out that the recent improvement in home values and housing construction were signs that the purchase of mortgage-backed securities are no longer necessary. He said that he “believes that the efficacy of continued purchases is questionable.”
Inflation hawks at the Fed worry that the sharp expansion in bank reserves could lead to future inflation, even if there are no signs at all of any immediate price pressures. But Fed Chairman Bernanke generally leads the way, and at the present time he still appears reluctant to take his foot off the accelerator with the economic recovery still fragile and inflation not a threat. He has stressed that any changes to the current program would not be a withdrawal of monetary stimulus and the program could be continued for a long time at a lower level and could even be increased once again if needed.
Mr. Bernanke emphasized this flexibility by saying in March that it still makes more sense to have a variable policy in which the amount of purchases responds “in a more continuous or sensitive way to changes in the outlook.” On the other hand, the Fed has never specified what it might finally take to prompt a reduction in its monthly purchases.
Payroll growth has averaged 208,000 a month for the last six months compared to 141,000 in the six months prior to the launch of the latest stimulus program last September. At the same time, the unemployment rate has declined to 7.5 percent last month from 8.1 percent in August and policy hawks have jumped on this improvement to say that the time for lessening the program has begun. Stay tuned.
Donald Selkin is the Chief Market Strategist at National Securities in New York, a veteran in the securities industry for 36 years who is widely quoted in the financial media. If you have any questions, contact firstname.lastname@example.org .