The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Good Evening: U.S. stocks rose once again on Wednesday, extending what has become a rather remarkable equity rally. Taken in context with another down day for Treasurys and the U.S. dollar (and another up day for commodities), market participants should be forgiven for feeling Yogi Berra’s sense of deja vu all over again. A slate of strong economic releases were in part behind today’s ascent in share prices, with readings for the CPI, industrial production, capacity utilization, and the housing market index all coming in at, or well ahead of, consensus expectations. A report of very weak international capital flows into the U.S. (the TIC report) was largely shrugged off. What has been harder to overlook is the continuing strength of the U.S. stock market. It has left bulls and bears alike feeling confused. Very few investors seem to be feeling smart these days.

I will dispense with the usual recap of the day’s market action, offering instead the following summary. Most of the major averages went steadily higher all day and finished with gains of between 1% and 2%, though the Dow Transports were the exception by finishing flat. Treasury yields rose to challenge their September peaks, the dollar took another header, and commodities almost outdid stocks when the CRB index posted a gain approaching 2%.

“Never confuse brains with a bull market” is one of Wall Street’s oldest pieces of advice for investors. It teaches us to not feel too smug or smart about the levitation in one’s portfolio when the major averages, too, are rising. If what has been transpiring at the corner of Wall and Broad streets since March is indeed a bull market, then the usual celebratory cockiness is missing. Of the seeming lack of joy over this latest rally, one of my readers relayed the following impression of her recent trip to New York : “Even the ones who are making money aren’t happy”, she said. And frustrating as this essentially one way trip higher in stocks has been for the bulls (the under-invested ones, anyway), it has been more painful than a declawing for the bears.

With so few people feeling smart, is there any identifiable group exchanging high fives these days? Next week’s FOMC meeting might be the site of at least a few quiet ones. When the governors gather inside the Eccles building, one or two will no doubt smile when the Lehman anniversary and the August economic data come up for discussion. Catastrophe apparently averted, the Fed will be tempted to take a few bows. After all, and at the risk of being compared to President Bush’s 2003 carrier landing beneath the “Mission Accomplished” banner, didn’t Chairman Bernanke’s “the recession is likely over” statement yesterday betray at least some sense of achievement? The mood around the conference table will turn somber, however, when the FOMC gets around to deliberating about an exit strategy. There might even be a lonely voice asking whether or not the Fed should soon start the process of draining the pool of liquidity in which the global capital markets have been swimming for most of 2009.

Student and teacher of history both, Chairman Bernanke will probably cut short any “it’s time to take away the punchbowl” discussion by citing a similar policy mistake made during the Great Depression. Mr. Bernanke might not directly quote Jim Grant’s excellent book, “Mr. Market Miscalculates — The Bubble Years and Beyond”, but it would be appropriate if he did so. “(I)n 1935, it (the Fed) was given the power to set reserve requirements. It presently doubled reserve requirements, thereby entering a strong claim of paternity for the nasty 1937-38 recession…” (Page 261). Removing the stimulus too soon and risking a relapse in the economy is one of the many lessons of the Great Depression Chairman Bernanke is likely determined not to repeat. Remember, too, that his re-nomination has yet to receive approval in the Senate.

Even so, Mr. Bernanke might allow some mild exit strategy language to be inserted into next week’s statement. Even if the risk of a future inflation is the last thing on his mind, he may still not want to risk losing the bond market just now. Thus, any talk about removing monetary stimulus will probably be just that — talk. Mr. Bernanke will see to it that money printing will be with us until the bond market grounds his fleet of helicopters. Until that day comes, stocks could continue to be kited higher on the winds of easy money. Maybe, just maybe, Mr. Market came to this conclusion when quantitative easing measures were announced by the Bernanke Fed back in March. If so, he’s probably one of the few who feels smart these days.

– Jack McHugh

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