Written By Keith Springer
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Every day we read the news on how bad the economy is. Unemployment is astronomically high (even Ben Bernanke admits it will take at least 5 years to bring it down), housing is in a veritable depression and not likely to recover for 4 or 5 years and people won’t buy more stuff (mostly stuff they don’t need anyway, but that’s the American way) because they are already leveraged to the hilt. Yet the stock market continues to rise. How can that be?
There are 3 basic reasons:
- Interest rates are low and are expected to stay that way – You don’t fight the Fed
- The trend is rising – You don’t fight the tape
- Corporate earnings have been stellar and will continue to be – I have no cute euphemism for this one but earnings are important, in fact the most important.
The first one, low rates, is easy to understand. The economy stinks and the Ben Bernanke and his financial puppeteers are throwing everything including the kitchen sink at this. All economic indicators are being perverted more than at any time in our lifetimes by the unprecedented government stimulus program meant to keep an economy that wants to deleverage and rid itself of debt from going down and rebalancing. That is understandable, as the establishment from the government to the financial services industry does not want to reap the natural consequences of the unprecedented credit bubble. Unfortunately for us it is creating another stock bubble.
The 2nd, the trend, is directly related to the continued intervention by the Federal Reserve through stimulus and so called quantitative easing (which is simply printing money). The market likes this… actually it craves this and can’t live without it. That’s why I call this the “Great Viagra Market”. As long as they are willing, (more likely able) to keep throwing free money into the system, this market will keep on chugging along.
Don’t get me wrong, I too hate the idea that our deficits rival that of a banana republic. Yet they are clearly committed to fighting the natural deflationary cycle that occurs after every generation. The government is committed to the more immediate economic concerns and will continue to throw money at the situation.
The 3rd is what drives stocks the most in the short term: Earnings. Companies are generating great earnings in this rotten economy by fighting for survival. They hoard cash and strengthen their balance sheets by cutting costs and laying people off. Naturally, it is survival of the fittest, making the larger corporations better able to survive an economy like this, at the expense of smaller less efficient companies. Some will be bought out, some will merge and some will go by the wayside: “The Great Shakeout”. Anyway you look at it; it leads to fewer jobs and a slower overall economy but with very selectively efficient corporations left standing.
What this does is make individual companies very attractive even though the economy “slogs through the mud”. It is these large companies that largely represent the major indexes like the S&P 500 which has only 500 stocks or the Dow Jones which has only 30 stocks. And because we focus on these indexes, it looks like the market is rising. Eventually, the bad economy will trickle up to the larger more efficient companies, which will be evidenced with poor earnings. That day is not today. As long as earnings are growing the rally will be fine. Once earnings peak, the bubble will burst.
That’s where we can help. Our active hands-on approach to managing portfolios can help you manage risk and deliver returns. Call me for a free consultation today at (916) 925-8900.