The recent jawboning between the US and their Chinese counterparts is not only being played out on the diplomatic front (with Treasury Secretary Geithner making a house call) but also in the financial markets. The bump in rates by China, instead of allowing their currency to “freer” float certainly confused investors’; however the reaction to a reduction in liquidity was very certain: sell risk assets.
A day later and after much consideration, the financial markets were back to their usual ways – lower dollar, higher equities, commodities and bonds, with little support from the Fed Beige book that reported a still soft economy and uncomfortably high unemployment and low inflation. Investors should be watching economic data, however, as is usual this time of the quarter, corporate data now trumps the economy. Better than expected data from some of the largest stocks in the markets were enough to push stocks, at least temporarily, higher. The real issue is not so much the economy (still below “normal” growth for this part of the cycle) nor is it earnings (still fairly good – corporations currently have all the money!), but the amount of quantitative easing the markets expect in early November. While the election may indeed be about the economy, in the financial markets, it is about the amount of QE II.
Investors wondering how much QE II is already baked into the market might be missing the bigger picture that it WILL happen. Whether it comes in a shock and awe or in pieces over time misses the point that the Fed is very intent on putting additional liquidity into the financial system, which is serving as fuel pushing stock prices higher. The market rise in anticipation of QE II does leave the door open for disappointment when the Fed does act, however the fact will be additional liquidity into the financial system, which ultimately will find its way into the equity markets as investors hunt for returns. The focus by the Fed on reducing yields across the curve will reduce the already paltry rates investors are getting to park their money for safe keeping – it forces money to places that it will be treated well and for now that is the equity markets.
It is no surprise that the consumer is struggling under the weight of debt and uncertainty around jobs. As a result, consumer balance sheets are in need of repair buy spending less and saving more, which has been happening ever so gradually over the past year. As the consumer cuts back spending and begins the arduous task of cutting debt, the government worries about “jump-starting” economic growth. At this point, we are counting out the consumer as a key driver for immediate growth in the economy. The next component is the government – which has the ability to print money when necessary. That fact aside, the government, as well as the Federal Reserve are sitting on a large pile of debt and are in need of the good graces of others to continue buying the debt to keep things going. Government actions in the financial markets are leaving huge foot prints – from lowering the dollar (by flooding the financial system with money) to constraining capital formation by a still cloudy tax policy in addition to new regulations that begin impacting companies in 2011. Given the actions so far and their economic impact, I am counting the government as having negligible impact on creating economic growth (some positive impacts such as cash for clunkers have proven to be temporary and potentially deleterious in the long-term).
That leaves the corporate structure to provide some economic help. Here the balance sheets are in great shape, with high cash levels and in the case of large cap stocks, easy access to debt (witness Wal-Mart and IBM debt issuance). As this earnings season has developed, there are a couple of points worth noting, first: the more international the company, the better the earnings. Indeed comments from many of the CEOs indicate that growth has been much better in the international markets than domestic (McDonald’s and Caterpillar as examples). As is normal during earnings season, many of the companies also talk down outlooks in order to dampen expectations for future quarters.
So what are companies doing with the excess cash that is burning a hole in their earnings statements? Some are indeed spending money on improving operations, however many are looking at mergers/acquisitions to help boost bottom line numbers. Many of the mergers have been strategic in nature, but there have been some barnburners like the chase for 3Par by Dell and Hewlett Packard. The good news is obvious for the target firm; however the aftermath is usually not a benefit to the economy as companies usually have staff cuts and reduce the amount of suppliers providing goods/services to each of the firms.
So what is the bottom line? For now, the equity markets look to gradually move higher through the end of the year as the Fed begins QE II and investors, instead of trying to figure out which stock to buy, focus on the broader ETF baskets. As a result, the usual technical indicators that may show some divergences in the markets are not giving “normal” signals at this point. Stay focused on the advance decline line.
click image to enlarge
The lower left to upper right chart is showing broad participation in the rally. The sideways action in the chart from April to mid-September coincided with the struggling market that has been recently resolved to the upside. Until this turns significantly lower, the markets are likely to trade higher.
