The equity markets are getting a dose of reality as a series of economic reports and continued strong demand for U.S. treasuries weigh heavy on the minds of equity investors. A mediocre durable goods report combined with unexpectedly poor new home sales and consumer confidence data to push equity markets lower. Another strong treasury auction, this time the five-year note, demonstrated that not everyone is convinced the global economy is out of the woods.
In spite of the best efforts of market bulls and government officials, consumers and investors are wising up to the fact that much of the improvements observed in economic data has been due to inventory replenishment, after a long period of depletion, and government stimulus. Goldman Sachs cut its forecast for third quarter GDP to 2.7% from 3.0% due to the lackluster durable goods data. I believe Pimco’s Bill Gross had it right when today he said in an interview on CNBC: "The new normal recognizes the economy is deleveraging."
The problem is that the government is trying to leverage the economy back to health. Are government officials stupid? No, they are merely politicians. These hypocrites who criticized Wall Street for focusing on short-term profits over long-term results are guilty of the same offense. Rather than let the economy correct to fundamental growth rates and permit home prices to find levels at which those who can obtain credit (a shrinking group thanks to an over supply of homes and rising unemployment), the government is attempting to repeat past mistakes of too much leverage in an attempt to engineer another sharp, quick, but unsustainable recovery in order to keep the voters happy and themselves in office. They are sacrificing long-term prudence for the short-term goal of remaining in power.
This is what got us here! For nearly three decades, whenever the economy would falter, the Fed would bail out the economy by lowering rates. Wall Street helped by creating vehicles to package all kinds of sour loans into palatable investments. Politicians permitted (some encouraged) this to happen. All was good as long as the populace was happy and politicians remained in office.
The government is reaching way back in search of mistakes to make. The administration and its partners in Congress are pushing for wage and price controls and extension and expansion of stimulus plans such as the first time home buyer credit which may become available to existing homeowners looking to upgrade to a larger home. The government is also choosing favorites among corporations. If one lends to and for unionized businesses one can get government assistance. If one lends to small or medium-sized businesses, which are largely non-unionized, one is left to fend for oneself. Just compare GMAC to CIT.
The demand for treasuries is likely to remain strong as I (and most other fixed income experts) am expecting strong 10-year note and 30-year government bond auctions. If the Fed tightens, the lack of cheap leverage will take many equity buyers out of the market. The weaker dollar was also helping to buoy stock prices. As the dollar weakens more of them are required to represent the value of companies, hence share prices rise. Fundamentals will eventually rule, that is why we have corrections.
The true colors of the economy are about to come shining through .