There is nothing like central bank easing to get investors flocking to equities. As expected the ECB moved on Thursday to cut interest rates and also announced additional stimulus measures. The ECB’s main lending rate was reduced from 0.25% to 0.15%, and they also introduced a negative deposit rate on cash that banks have parked with the central bank. The goal is to incentivize more bank lending, aka. increase the money supply. The ECB also alluded to preparations for direct purchases of loans and made clear that the door remained open for additional measures to come if needed.
This took equity prices around the globe to new highs. The Dow and S&P rallied into new-high territory. The strongest gains came from the Russell 2000 small-cap index which traded up almost 2%.
European stocks surged to a new post-recession high.
News of easing helped stem the precipitous fall in gold prices over the last two weeks. But to be clear, the chart below remains quite bearish. On May 29th we saw a “death cross” in gold as the 50-day moving average crossed below the 200-day moving average, confirming that momentum remains to the downside. I think yesterday’s bump is more likely a dead-cat bounce than the beginning of a reversal in trend. Part of that assessment has to do with the lack of follow through we’re seeing today, and I also think more investors are wising up to the fact that central bank easing does not imply hyperinflation.
If you were watching the market closely you would have noticed that yesterday’s move higher had a secondary catalyst and that came from Hedge Fund Guru David Tepper. In mid-may, Tepper spoke at the Skybridge Alternatives (SALT) conference in Las Vegas. Known as a perma-bull, the markets had a fainting spell after hearing David’s comments. Specifically, he said, “I’m not saying go short, I’m just saying don’t be too fricking long right now.” Tepper’s May comments circulated the globe and our oh-so-wonderful media propagated the message through headlines such as “Calm Before the Storm” and “Time To Sell This Stock Market? Two Pros Think So.”
Yesterday Tepper reversed his position, noting that his chief market concerns have been “alleviated.” One of Tepper’s largest concerns was the reluctance of the ECB to act. After seeing the new measures put forth by the ECB, he felt it necessary to change his tune.
I mention this because if you look at the market’s action yesterday, the rally came not after the ECB’s comments, but after Tepper’s reaction to the ECB moves. This is a perfect example of what’s known in psychology as the Authority Bias. It refers to the tendency of individuals to take on the opinion of someone who is seen as an authority on the subject. The initial response to the ECB’s actions was muted, until a major industry expert stepped forward to help interpret and validate the positivity of those actions. After hearing Tepper’s reaction, the herd felt comfortable trusting his authority and the market rallied. For those who are unfamiliar, Tepper manages the $20 billion dollar hedge fund Appaloosa Management.
This is a prime example of how human our markets are, and that not everything is driven by estimates and earnings. Rather, it’s the psychological component that often carries markets higher or lower, and this psychological component of the masses is NOT necessarily logical. Hence why we spend so much time emphasizing following trends rather than second-guessing them based on our own rationalizations.
An interesting article appeared in Business Insider, accompanied by the chart below. This chart looks at the sources of personal income for Americans. As you can see, since 1980 there has been a steady decline in the percentage of income received from wages and salaries. Much of the loss in income from direct labor is being offset by an increase in transfers, which include items like social security, Medicare, disability insurance and food stamps. This is not a bright picture, as it suggests less productivity and an increased burden on tax payers who support all these “transfer” programs.
It’s also interesting to note that the green section, receipts on assets, has been trending marginally lower. I would venture that much of this has to do with the falling interest rate environment we’ve seen over the past three decades.
Without a doubt the aging of the population is a major driver of the trends seen above. But policies that support entitlement programs, discourage hiring by making it cost prohibitive, and a tax code that incentivizes businesses to transact elsewhere are all culprits of this changing dynamic.
To end on a more positive note, at least the data shows that more people are taking their futures into their own hands, as proprietors income slowly but gradually improved.
Markets are again pushing to new highs today. Employment data released over the last two days continues to paint a very positive picture for our economy. Yesterday jobless claims came in at 312,000, right in line with estimates and again near post recession lows. In my March 25th remarks I discussed the usefulness of jobless claims as a leading economic indicator. We are still not seeing the classic rise in jobless claims that typically precedes recessions by roughly a year. The 4-week average of jobless claims now sits at its lowest level since June 2007.
Following on the heels of yesterday’s jobless claims figures, today the widely followed nonfarm payrolls data was released and also provided an upbeat view of the economy. The report showed 217,000 jobs were created in May. This marks the first time the economy has added 200,000 jobs or more in four consecutive months since 1999.
We posted some comments from John Williams in yesterday’s site and I have to say that I frankly could not disagree more with his take. I understand that we have a lot of problems in the US, but so does the rest of the world. And I also get that we will unmistakably see a major correction or bear market ahead. But right now we’re experiencing a perfect storm of factors acting to drive equity prices higher. Corporate profits are near record levels, margins are strong, labor and manufacturing are improving, we’re on the cusp of an energy boom, and central banks are keeping rates low, improving the attractiveness of equities over bonds. It should not be surprising to anyone that the stock market is at all time highs.
I don’t agree with Williams, but I do respect him; and I actually need him and all the folks who think like him. I need them because someone has to take the other side of the trade. The stock market is a zero sum game, meaning for every winner there is a loser. Without folks who entertain an opposing thesis, there would no market dynamics to support wealth creation.
Late Notes — Dow, Transports and S&P 500 all closed at record highs. Small-caps were again the best performers. The Utilities were the only major index to close in the red, indicating a continued shift from defensive positioning back to offense, and suggesting continued gains ahead.