In the roughly 3-month period from November 15th, 2012 to February 19th, 2013, the S&P 500 has gained over 14%. Personally, I don't find it surprising anymore for the equity markets to go up while the macroeconomic outlook remains anemic. One of the main excuses for the disconnection between equity markets to the economics data was the claim or at least perception that companies' earnings are improving and will continue to improve. That was a myth a couple of months ago and it's clearly false right now. Nevertheless, equity markets seem to be unstoppable and keep on marching higher almost daily. I think that this is way too much, way too fast.
Take a look at the market consensus for the S&P500 EPS for the first quarter of 2013:
Since November 15th, 2012, the market consensus has dropped by over 4%!
In a way, this is the 4%+ correction that I predict for the S&P
Furthermore, here is the market consensus for the S&P500 EPS for the entirety of 2013:
Once again, the negative trend is obvious.
So why is the market going up? The answer lies on the Fed's balance sheet:
Source: Federal Reserve Board of Governors
There's nothing more powerful than QE and there's apparently zero correlation between the market's trend and macroeconomic data. The Fed gives and the Fed takes. The big question is how will it end? How will the Fed find its way out?
While I don't expect the Fed to actually back-off its monthly $85 billions money printing I do expect the Fed to change its tone over time. Although I expect the Fed to flood the market with cheap money during the entire 2013 I also expect the Fed to speak a different language and to pave the way for its exit. This has to start at some point and the sooner - the better.
As long as the market is going up - nobody seems too worried. It was less than 2 months ago that everybody spoke about the Fiscal Cliff all the time. Now, it seems like nobody talk about the Sequester which is only one week way.
The markets seem to treat the Sequester as a non-issue at all. Nonetheless, the automatic spending cuts that are going to get into effect on March 1st won't be so easy for the economy to digest.
Unlike the markets, president Obama does understand that the Sequester is an issue that shouldn't be ignored. Admittedly, there's no much he can do about it, taking into consideration that the Republicans apparently have made their minds not to negotiate any type of solution (after what happened at the end of 2012, can anyone blame them for it?) Nevertheless, on February 19th, the president tried to step up pressure on Republicans to work to avert next week's scheduled 'sequester' spending cuts. He described the upcoming Sequester as a 'meat cleaver' that will for sure hurt the economy.
By using the 'meat cleaver' analogy president Obama is trying to claim that cutting spending in an automatic, rough way will mainly hurt the US Army's level of preparedness, something that - so he hopes - touches the hearts of many Republicans.
It's crucial to read between the lines. Obama's speech came in light of the proposal - initiated by Erskine Bowles and Alan Simpson, the deficit hawks who co-chaired the White House's 2010 deficit-reduction committee - to cancel the Sequester in exchange to an alternative plan to cut the deficit by $2.4 trillions over the next 10 years.
The two gentlemen are naively calling for deeper cuts in expenses, mainly pensions and healthcare, alongside higher taxes, $600 billion to be more precise, over those 10 years.
What are the odds for this plan to go through? I believe that the answer is zero.
The inability to get the two sides to agree on basically anything ensures that they will continue to kick the can down the road.
The problems haven't disappeared; if anything, they only get deeper and become more difficult to get solved. But as long as the markets seem to very much like this "kick the can" ongoing game, I see no reason for politicians not to stick to it.
Once again, as in previous episodes, the president is blaming the Republicans, asserting that if the Sequester goes into effect, it will show that they are willing to sacrifice the economic recovery, creation of new jobs, security readiness and educational projects for their political ambitions.
The Republicans, on the other hand, blame the president for not coming up with a serious alternative plan that can even be considered in exchange for the sequester.
Haven't they become tired of this? Perhaps they have, but as long as the markets go up, who cares?
Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.