All major U.S. stock indices began Monday’s session higher, but weakness set in about an hour into trading.  The Dow Industrials managed to gain decent ground thanks to the shares of JNJ, Wal-Mart and 3M.    The S&P 500 and NASDAQ Composite ended essentially flat as the former posted a fractional gain and the latter a fractional loss.

Basic material, health care and telecom shares were the best-performing groups – all closing higher.  Tech and financials were the biggest losers. 

After sliding 6.6% mid March, the CRB Index has bounced back to just shy of the post-bubble high mark hit four weeks back.  The prices of wheat, corn, silver, sugar and OJ led the measure higher.  The energy complex was mixed as crude and wholesale gasoline inched higher, while the price of natural gas slipped.  (The wholesale price of gasoline closed at $3.17/gallon yesterday; the national average retail price is $3.68.  That’s about 15 cents shy of the normal spread.)

The U.S. dollar had been getting beat by the euro over the past couple of months as the ECB has been signaling they’ll hike their benchmark interest rate from the emergency level of 1% even as the Fed holds zero interest-rate policy (ZIRP) fully intact – and even beyond that as QE remains in play, for now.  But over the past couple of days, concerns over EU debt have set in again and the greenback has found just a little life against that currency.  The buck has been gaining ground again the Japanese yen, but then we’ve got the G-7 intervening to boost $/yen so that’s not very surprising.  One has to take the yen out of the mix since its being grossly manipulated, so we’re forced to watch dollar against the other major weights within the Dollar Index, which are the euro and British pound.   The dollar is down against the pound this morning, continuing a trend that’s been in place since the year began. 

Market Activity for April 4, 2011

Sector Activity for April 4, 2011

ZIRP/QE is Not a Solution; It’s a Front

I remain stunned each day, although less so as we progress down this monetary road of perdition, at how the market continues to shrug off an abundance of geopolitical risks and structural economic issues – it would normally take just a couple of these challenges to send investor confidence sliding and probably stock prices too.  Some people have defined the market’s behavior as one of resilience; I’ve even used the term on occasion. 

But resilience seems to be the wrong word to define the stock market’s levitation act – I’d say resilience can be the proper term if the market remains buoyant even when the Fed begins to tighten, reversing from the most aggressive policy in the central bank’s history, but not before.

What we’ve got right now would more appropriately be termed an “Eminence Front,” to borrow the title from The Who’s 1982 release. It’s a façade created by the monetary equivalent of financial cocaine.   Even the strongest part of this economy – corporate balance sheets, which is the only thing one can point to as being fundamentally sound – has come at the expense of both job creation and the saver.  That is, without the most aggressive slashing of payrolls in the postwar era (and the weakest job recovery from deep decline) and extremely low interest rates the earnings and debt refinancing that has delivered strong corporate financial positions would not have occurred. 

(And I should make it clear that when I talk about a façade and the ability of the stock market to seemingly ignore an abundance of challenges, I’m referring to the last 40% of this rally from the March 2009 low.  As longer-term readers should know, I believe fair value is a range of 900-950 on the S&P 500, so the first 45% of this rebound was fundamentally sound, in my opinion.)

While the Fed can keep the façade going for a long time in fact, they cannot solve the plethora of problems that we face.  (Endogenously speaking: The massive debt levels among both household and government sectors, and what will be soaring debt-servicing challenges when interest rates normalize; a very troubled housing market; rising food and energy costs and the negative real wages that result; high joblessness and record levels of long-term unemployment.  Exogenously speaking: There’s the Mideast that looks set to take chaos to a whole new level; the situation in Japan; and inflation pressures currently afflicting emerging-market economies, forcing those central banks to tighten)  No, Bernanke and Co. cannot solve these issues; they can only create an environment in which no one cares. 

So the market has embraced a Fed that once again implements reckless monetary policy, but Bernanke & Co. must eventually unwind (just as Greenspan & Co. had to do a few years back and Volcker took it upon himself to unwind the mistakes of Arthur Burns and William Miller in the 1970s). And when they do I’m afraid all of these issues will become highly conspicuous. 

Ultimately, there is only one solution to the endogenous problems, and that’s allowing the market to work.  The market is the only system that will force the repair of these issues.  It not a pretty solution, but as we’ll find out neither is delaying the process – as we’re now seeing in the housing market.  And beyond simply delaying repair, such aggressive central bank actions may actually be causing additional challenges that will have to be dealt with later.   But for now, stocks carry on. 

History shows monetary fronts don’t end well.   So long as you understand all of this, you’ll keep the proper amount of safety in the portfolio.  Therefore, when the market slides you’ll be left with more resources to redeploy into higher risk areas of the market -- at prices that offer levels of expected annualized returns that are commensurate with the risk one takes when investing in stocks. 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900