April 4, 2016

Bulls could be their last laugh for this economic cycle

Stocks celebrated Federal Reserve chair Janet Yellen's dovish comments and the party has been continuing. However:

-    As I suggested months ago in my "2016 Surprise List" , it seems unlikely to me that there will be any Fed hikes this year (especially given the global economic slowdown). Not only that, rate hikes in coming years appear likely to come more slowly than the Wall Street consensus anticipates.
-    Yellen contended that the Fed has "considerable scope" for stimulus, although I can't see where any potency lies.
-    The central-bank chief said her definition of full unemployment might be lower than previously thought, and that the U.S. inflation outlook is more uncertain.
-    She also continued to expand her definition of the Fed's "data dependency." It now apparently includes the Chinese Purchasing Managers Index, European Union Industrial Production, South American currency rates and, of course, global stock and credit markets' health. 
-    The Fed chair said that "economic and financial conditions remain less favorable than they did back at the December FOMC meeting." She also frequently used the word "global."
-    Yellen also said "movements in bond yields act to buffer the economy from shocks, serving as an automatic stabilizer."
-    Lastly, she stated that a further drop in oil is bad for the global economy.

Overall, I believe yesterday's speech contradicted recent comments by several Fed regional presidents -- and underscored the central bank's documented poor forecasting skills. The Fed's economic projections (even those of the last two months) have continued to be wide off of the mark when the actual figures later come in.

I think Yellen's remarks also serves as proof-positive that the Fed lives in constant fear of a fall in capital markets and the likely negative-wealth consequences that would entail. (And to me, that fear is certainly justified.)

History Might Provide an Ugly Precedent

However, the last time the Fed moved from tightening to dovishness was back at the end of 2007, and we all know how that ended -- badly.

This time around, I believe that Yellen is attempting to sustain the economy's misallocation of capital but will end up giving us a "gift" of stagflation in the future (perhaps in the not too distant future).

In fact, the only thing that surprised me after Yellen's speech was the market's bold and constructive reaction to it.

Saxo Bank Chief Economist Steen Jakobsen captures my thoughts and concerns perfectly. Jakobsen told CNBC that he believes that the "social contract" between the rulers and the ruled has been broken.

In a recent research note, he wrote that the ratio between U.S. employee compensation and gross domestic product is the lowest in history even as corporate profits are at their highest point ever, according to CNBC. Jakobsen sees this as a key reason why so many voters want anything but the status quo.

He also told CNBC that the antipathy toward how the world's central banks are handling the economy also reflects a break in the social contract.
"We have glorified central bankers in the world today who have behaved like rock stars," the economist said. "Some of them, like [European Central Bank President Mario] Draghi, clearly enjoy being in the limelight. But the effect of what they do, the marginal impact of what they do, is deteriorating -- and massively so."

That's why I personally remain bearish. I'm fading the positive response to Yellen's speech.

To this observer, the combination of a bullish stock market and a bearish global economy doesn't add up after seven years of monetary easing that failed to address structural issues.

Besides the elevation of financial asset prices, there's been absolutely no evidence that I've seen over the past two years of the Fed's quantitative easing and 0% interest rates having any direct, positive influence on U.S. economic growth.

The cost of money isn't a material constraint on economic activity, so I don't believe that keeping rates lower for longer will have any important impact. Instead, I think stocks are rising mostly thanks to The Church of What's Happening Now.

Of course, many others feel differently. Just check out today's columns from my Real Money Pro colleagues "Rev Shark" and Jim Cramer. They see Yellen's strategy as a profit panacea and a "green Light" for stocks.

But I see many "peaks" out there -- in stock prices, profit margins, market breadth, housing, autos, commercial real estate, buybacks, M&A, China, Apple and more. And to me, nothing Yellen said yesterday changed any of that.

The bulls are getting the last laugh for now, but it might literally be their last laugh of this cycle. To me, the global economic glass is still half empty and promises not to change in the year ahead -- even in the face of a dovish Fed stance.

via thestreet