Open Your Mouth And Buy Stocks?

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Includes: DIA, QQQ, SPY
by: Scout Finance

Summary

The Fed is pushing up stock prices.

How long can this last with a weakening economy?

S&P 500 profit margins are peaking.

The Federal Reserve has played a part in this recent rally in stocks. As someone who believes the Fed has caused substantial harm to the economy with its ZIRP and QE experiments, I am not excited to see the governors constantly making headlines. It is as if they see themselves as actresses or sports stars. The reason I love investing is because I enjoy researching companies and macroeconomics. However investing has been transformed over the most recent years into trying to decipher each new terminology the Fed creates. The reality is the Fed cannot manipulate the business cycle to make it grow forever. The credit cycle will always occur. However, the stock market can be manipulated by whatever the newest 'word of the day' is.

I don't think the economy is strong, meaning I never expected any rate increases. We received one token rate increase in December and none since then. I am just telling you this to make you aware of my baseline expectation. Going into the year there were expectations by Fed governors and market participants for several rate increases. There were talks of 4 or more rate hikes. Going into the latest Fed meeting in March the Fed had the expectation for 4 rate increases. The market wasn't discounting this at all, so it was safe to assume the market would have went down hard if this open mouth policy was maintained and an actual increase of 25 basis points was made. However, the Fed acquiesced and guided towards raising twice in 2016.

The Fed seems to focus on the labor markets and inflation to make policy. However, generating stock market returns have also been on its radar. It used to be a conspiracy to say that the Fed was manipulating the stock market even though it was obvious, but it became an irrefutable point when Dallas Federal Reserve President Richard Fisher said that the Fed front ran the market in March of 2009 to create a stock market increase to spur the 'wealth effect' created by equity gains. He has also mentioned QE doing the same thing. Therefore, it wouldn't be outrageous to say the Fed acquiesced to the market to avoid a further correction.

Looking at the CME Group website, we can see the Fed is expected to raise rates either once or twice by December. Even if the Fed raises rates, which is goes against what I expect, having rates this low going into the beginning of the end of the business cycle in problematic. In my opinion, a recession is coming in mid-2016. With this Fed policy even a recession delayed until 2017 causes problems as the Fed won't be able to cut rates much going into it. The only way you would think this Fed policy is good is if you believed there will never be another recession again or at least not one until 2018. This is preposterous as recoveries rarely last that long.

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The chart from Zero Hedge shows my point in a globalized fashion. Coordinated easing by central banks will cause stocks to go up, but if growth doesn't follow then it can't last. Stocks can't survive on buybacks forever. Earnings growth is the only thing that can drive sustainable increases in the S&P 500. The Fed is becoming no different from the Chinese government buying stocks to prop up the market except the Fed is doing it indirectly.

The declining profits I am mentioning can be seen in the chart below. The S&P 500 profit margin cycle is peaking. Can the recovery keep going? Anything is possible, but the recovery has already been longer than the average one, so any weakness should be interpreted as an end to the cycle in my opinion.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.