The S&P rose 40 points (+2.96%) last week, reaching a new closing high above 1680. The biggest gain came Thursday, following a series of positive economic indicators and Ben Bernanke's dramatic change of heart on U.S. monetary policy. This week, second-quarter earnings announcement season will begin in earnest. Currently, analyst expectations for second quarter sales and earnings are so downbeat that any positive surprises will likely result in a continued rise to yet more new market highs.
Bernanke Changes his Tune - Causing a "Bernanke Bounce"
The market's biggest bounce last week came after the Federal Open Market Committee (FOMC) minutes were released on Wednesday revealing a vocally divided Fed with the "doves" firmly in control. That much was expected. But then, Chairman Ben Bernanke gave a speech in which he said that "highly accommodative monetary policy for the foreseeable future is what's needed in the U.S. economy."
Wow! Fed watchers like Ed Yardeni were stunned with Bernanke's 180-degree turn from his May references to "tapering" the rate of quantitative easing (QE) this summer. Yardeni explained Bernanke's conflicting signals by saying that Bernanke essentially said, "Ignore everything my colleagues and I have said in recent weeks. Buy bonds and stocks!" The market obeyed and we saw a "melt up" in stocks.
I suspect that Bernanke saw something in last Friday's June payroll report that he did not like - and there was a lot to "not like" in that report, such as the average workweek remaining at 34.5 hours (too low for robust job growth), too many 25-to-54 years old are still struggling to find work, and too many new jobs are temporary and/or low-paying service jobs. The rise in "non-voluntary temporary jobs" (by those looking for full-time work) pushed the U-6 unemployment rate from 13.8% to 14.3% in June.
The fact of the matter is that Bernanke probably realized he was coming across as overly optimistic when he spooked the bond markets with talks of "tapering," implying that a more robust GDP will make further easing unnecessary. In other words, Bernanke "missed the broad side of the barn" with his May economic forecast and had to do an abrupt "about face." So let's call last week the "Bernanke Bounce."
Bernanke's return to the dove's basic playbook means that the very few and very vocal hawks who run a handful of the Federal Reserve's district banks are irrelevant. They are not voting members of the FOMC, so their calls to end or curtail QE are futile. The doves remain firmly in control, representing 11 of the 12 voting members of the FOMC, and if Chairman Bernanke retires next January, his replacement is likely to be an even bigger dove, so the Fed will likely keep pumping out new money in 2013 and the foreseeable future.
Central Bankers as Monetary Engineers - our New "Masters of the Universe"
The FOMC minutes revealed that "many" of the doves said that further improvement in the outlook for the labor market would be required before it would be appropriate to taper. Additionally "some" of the doves wanted to see an acceleration in GDP growth rates before curtailing quantitative easing. Finally, although "several" FOMC members judged that winding down the Fed's money pump is inevitable, this significant action remains dependent on improving economic data that has simply not materialized yet.
Another important point to remember is that if and when the Fed finally turns off its money pump, it will not raise short-term interest rates, even if the unemployment rate falls below the Fed's initial target rate of 6.5%. Bernanke said that given the weakness of the labor market, along with low inflation, "it may be well after we hit 6.5% before rates reach any significant level." This statement is consistent with all of his previous comments and with similar statements from the Bank of England and the European Central Bank (ECB). Interestingly, both Bernanke and the ECB President are MIT-trained economists who seem to believe that it is possible to "engineer" a recovery in financial markets by fine-tuning monetary policies to boost business and consumer confidence, making central bankers our new Masters of the Universe.
In particular, Bernanke has told Congress and the London School of Economics that he is not just trying to save the U.S. economy, but he and other central bankers are saving the world. The Fed Chairman has also said, in a testy exchange in his most recent Congressional appearance, that if the Fed turned off its money pump, the U.S. would have "0% GDP growth." It is clear to me that we are in the midst of a coordinated central bank plan to engineer a global recovery through money pumping and very low rates.
It is increasingly apparent to me that the short-end of the yield curve will remain as flat as a pancake for a long time. The world has clearly become "hooked" on the financial drug of ultra-low interest rates.
Stat of the Week: "Core" Inflation Stays near Zero (+0.1%)
On Friday, the Labor Department reported that the Producer Price Index [PPI] rose 0.8% in June, the highest monthly rise since last September and substantially above economists' consensus estimates of 0.5%. Excluding food and energy, however, the core PPI rose just 0.1%. Energy prices rose 2.9% in June, pushing the headline number deceptively high, but the long-term trend in energy prices is down, due to dramatic new energy recovery technologies that could help the U.S. become energy independent.
The U.S. consumer continues to be the brightest spot in the current economic recovery. Last Tuesday, the American Bankers Association reported that the credit card delinquency rate declined to 2.41% in the first quarter, the lowest rate since 1990 and well below the 15-year average of 3.87%. In the 13 categories that the American Bankers Association tracks, delinquency rates fell in 11 categories. In addition, CoreLogic reported that home foreclosure rates have also declined 27% in the past year. Now that default rates and foreclosures are low, this leaves more room for new purchases without paying penalties on accrued debts.
Not all of last week's economic reports were positive. Last Wednesday's report from the Commerce Department said that inventories fell 0.5% in May, despite wholesale sales rising by 1.6%. Inventories also declined by a revised 0.1% in April. This (and other sagging indicators) pushed economists' estimates for second quarter GDP growth down to only 1.5%, even slower than the first quarter's dismal 1.8%. This is yet another reason why we believe Bernanke's Fed will not immediately curtail its quantitative easing, since there is no evidence of accelerating (i.e., 2+%) GDP growth yet emerging.
However, U.S. growth is robust compared with Europe. On Friday, Eurostat announced that eurozone factory output fell 0.3% in May and is down 1.3% in the past 12 months. With six straight quarterly GDP declines, there is no doubt that the eurozone remains in a recession and is a drag on global GDP growth.
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