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Friendly Fed + Low Interest Rates = Economic Expansion

The economy continues to slowly mend following the devastating housing and credit bubble implosion during 2007 - 09. Expansions that follow busted manias are normally sub-par and anemic, this one is no exception. They require tons of stimuli - both monetary and fiscal. This can go on for years. Accordingly, this post-bubble expansion is following its expected and normal script. Most important, the U.S. economy is still healing, yet it is strengthening along an improving course.

Economy trending better

Overall the economy has trended better than expected despite the erratic monthly data. Manufacturing indices have reported bumpy month to month readings. Consumer spending and retail sales have been mostly better than estimated. Total retail sales in March declined -0.4%. Partial blame: the $200 billion in higher payroll taxes, colder than normal weather (a year ago March was one of the warmest on record), an earlier Easter holiday and the effects of sequestration. Meanwhile the International Council of Shopping Centers reported that sales in stores open at least a year rose 1.4% or 2.2% excluding drug stores. Further, auto sales are impressive. Housing data reflects steady up-trends.

Unemployment trending in the right direction

Job growth last month showed a disappointing 88,000 net new hires. Meanwhile the January payroll number was revised upward to 148,000 from 119,000. The February payroll gain was also recalculated higher to 268,000 from 236,000. The average workweek rose 0.3% for the second month in a row to 34.6 hours - the highest level in a year. More people with jobs. More take home pay. More money to spend. All without significant signs of upward wage pressure.

Improved credit conditions

The key to a continued economic recovery is credit expansion. Leveraging and growth go hand in hand. Access to capital is an essential ingredient. The most recent bank stress test results revealed the health of the largest U.S. banks is strengthening. This appraisal is also validated by the mega turnaround taking place for the bank stocks. The devastating collapse for the bank stocks pre-2009 has now successfully pivoted into a major industry uptrend. Observe the powerful turnarounds for both Citigroup (C) and Bank of America (BAC). This is supported by an increase in lending and dividends. These current potent uptrends will likely last for many years.

In addition, the credit conditions index has also pivoted into a sharp climb. This uptrend in credit is a very important factor for economic growth. Business expansions depend upon credit availability and leveraging.

Household borrowing has also turned the corner. This is a positive, dynamic economic force. Additional borrowing leads to more consumer spending. Consumer spending represents nearly 70% of GDP. Easy money translates into an expansionary economy and a rising stock market. Low interest rates, engineered by the Federal Reserve, encourage businesses to borrow, spend and invest. Nearly 45% of the chief financial officers at 202 surveyed corporations responded that they borrowed more funds in the last 12-18 months because of attractive interest rates and at more relaxed terms. About 50% of the CFOs spent the borrowed funds on new capital investments. Approximately 25% increased their merger/acquisition activity. Almost one-fourth expanded domestic operations. About one in ten boosted hiring. The Fed's easy monetary policy is designed to spur spending, investing and hiring. The economy is gaining traction. Critics claim the pulse rate for growth is frail and stalling. In fact, the trajectory and pace for this post bubble expansion is about on course. Many business executives comment that lenders are making more credit available. Commercial and industrial lending among U.S. banks show a healthy increase from a year earlier. Another positive and strengthening trend: the National Federation of Independent Business (NFIB) chart portrays that credit availability for small business is improving.

Low stock market confidence is bullish

Occasionally, contrary thinking is essential for investing. Extreme pessimism is often quite bullish for stocks. When one compares the Consumer Board's Consumer Confidence Index against the stock market, it shows that stock market tops occur when consumer confidence is in a high level zone. Conversely stock market buying opportunities are in place when consumer confidence is at low

levels. Like now! The pessimism reading is deep in a trough. Contrary thinking. Read this as bullish. In addition the bull/bear ratio for the American Association of Individual Investors (AAII) is at the lowest level since March 2009. This reflects that most investors are underinvested in stocks and are non-believers. Rank this contrary indicator as very bullish.

Summary

The slow growing economy will cause the Federal Reserve to stay the course with continued stimulus via low interest rates and Quantitative Easing (QE) for some time. This environment continues to be bullish for stocks.

Source: Friendly Fed + Low Interest Rates = Economic Expansion

Additional disclosure: taken from our May 2013 newsletter (which also contains charts/graphs).