After running straight up for the past week, the market was due for a little rest -- and that is exactly what we had. We inched down most of the day on slightly negative breadth, and average volume but popped back in the closing hour as market players anticipated the GOOG earnings report.
Google's stock was rewarded by expectations of a good report as shares of the company popped 30 points. Google's strong action hoisted up the broader market as well. This is the first big positive response we've seen this earnings season, and it is going to be very interesting to see how the company performs tomorrow as the news is digested.
The bears have one very big problem right now: with QE 2 in the air, it is very unlikely that they'll be able to make any significant inroads to the downside. The Fed's printing press is more powerful than earnings and economic news. With Ben Bernanke clearly in the quantitative easing camp, this market has some very solid underlying fundamental support to go along with the technical support.
The little dip today obviously did nothing to damage the uptrend that has been in pace since the Sept. 1. And with Google now putting up a strong report, the fear of being left behind will keep the upside momentum going.
We have GE's earnings report in the morning, and there are obviously some issues with financials due to the mortgage mess. But this market is focusing on positives and is ignoring the convenient excuses for selling.
Thursday, October 14, 2010
Wednesday, October 13, 2010
Thoughts
Financials remained weak, and retailers such as Kohl's, Target and Coach were down.
Large-cap tech did well, but the market's reaction to Intel's earnings was disappointing.
The 10-year U.S. note auction saw a bid to cover below 3.00.
TBT is breaking up an important moving average.
The 10-year U.S. note auction was so-so, with a bid to cover below 3.00 (compared to the last several auctions at over 3.20). Indirect or strong holders were at 42% vs. 45%.
Meantime, TBT is breaking up an important moving average.
I can't see the banking group making a sustained advance until there are signs of expanding loan demand.
Banks were mixed after JPM's results.
Confidence in the ultimate economic impact of QE 2 ("The Tepper Effect"), a zero-interest-rate policy for as far as the eye can see, reasonable valuations, the calendar trade (as investment managers are pressured to perform) and a nascent reallocation from fixed income into equities seem to be the reasons for the remarkable market ramp that began in early July.
Large-cap tech did well, but the market's reaction to Intel's earnings was disappointing.
The 10-year U.S. note auction saw a bid to cover below 3.00.
TBT is breaking up an important moving average.
The 10-year U.S. note auction was so-so, with a bid to cover below 3.00 (compared to the last several auctions at over 3.20). Indirect or strong holders were at 42% vs. 45%.
Meantime, TBT is breaking up an important moving average.
I can't see the banking group making a sustained advance until there are signs of expanding loan demand.
Banks were mixed after JPM's results.
Confidence in the ultimate economic impact of QE 2 ("The Tepper Effect"), a zero-interest-rate policy for as far as the eye can see, reasonable valuations, the calendar trade (as investment managers are pressured to perform) and a nascent reallocation from fixed income into equities seem to be the reasons for the remarkable market ramp that began in early July.
Panic Buying?
One thing I always find interesting on days like this is that, although there is much celebration about how strong the action is, nobody seems to be talking about the buys they are making.
Someone is obviously buying, otherwise we wouldn't be up 1%. But most of the articles I read indicate that traders are reticent to do much. There are always momentum players willing to chase giant moves on big volume, but it always surprises me how little buying I hear about on a day when the market is looking downright euphoric.
I suspect that it is the algorithmic and computerized traders that are primarily responsible for gunning the action rather than individual traders, and that is why the emotions don't correlate with the action. The computer-based traders have no sense of overbought or oversold -- they'll just continue to do whatever is working, and that tends to make upside momentum a self-perpetuating force.
What happened today was that a number of bears were looking for INTC's earnings report to trigger a top. What they didn't figure was that the market doesn't care about earnings right now. It's all about QE 2 and the weak dollar, and as long as the dollar remains under pressure it is going to hold this market up. Earnings are just a momentary distraction from the Fed, which is all that matters at the moment.
long INTC
Someone is obviously buying, otherwise we wouldn't be up 1%. But most of the articles I read indicate that traders are reticent to do much. There are always momentum players willing to chase giant moves on big volume, but it always surprises me how little buying I hear about on a day when the market is looking downright euphoric.
I suspect that it is the algorithmic and computerized traders that are primarily responsible for gunning the action rather than individual traders, and that is why the emotions don't correlate with the action. The computer-based traders have no sense of overbought or oversold -- they'll just continue to do whatever is working, and that tends to make upside momentum a self-perpetuating force.
What happened today was that a number of bears were looking for INTC's earnings report to trigger a top. What they didn't figure was that the market doesn't care about earnings right now. It's all about QE 2 and the weak dollar, and as long as the dollar remains under pressure it is going to hold this market up. Earnings are just a momentary distraction from the Fed, which is all that matters at the moment.
long INTC
Tuesday, October 12, 2010
Thoughts
Intel
No biggie.
The breathless commentary regarding Intel is laughable -- particularly as it warned back in August.
In line with revised/lowered guidance.
Bizarro World!
The FOMC minutes underscore a fundamentally weak domestic economy.
And the market's positive reaction to the minutes' release continues to underscore that the David Tepper market ("Bad News Is Good News") is still in place.
Recommended Reading
Financials Looking Fine
Nice turnaround in financials today -- a group that appears to be responsible for the turn in the overall market.
Just when everyone -- and that includes me (!) -- had given up on the sector!
Tab for Mortgage Mess
The foreclosure chaos could cost U.S. lenders $2 billion for every month that home seizures are delayed.
Today, FBR Capital's Paul Miller says that the tab for the foreclosure chaos could cost U.S. lenders $2 billion for every month home seizures are delayed.
Goldman Sachs, based on a continuation of QE and lower real interest rates, has raised its 12-month price target for gold to $1,650 an ounce from the prior forecast of $1,365.
Goldman's three- and six-month gold price forecasts now stand at $1,400 an ounce and $1,525 an ounce, respectively.
China Puts a Dent in World Equity Markets
China surprised the world's markets by raising reserve requirements for six commercial banks.
This put a dent in the world equity markets overnight.
long INTC
No biggie.
The breathless commentary regarding Intel is laughable -- particularly as it warned back in August.
In line with revised/lowered guidance.
Bizarro World!
The FOMC minutes underscore a fundamentally weak domestic economy.
And the market's positive reaction to the minutes' release continues to underscore that the David Tepper market ("Bad News Is Good News") is still in place.
Recommended Reading
Financials Looking Fine
Nice turnaround in financials today -- a group that appears to be responsible for the turn in the overall market.
Just when everyone -- and that includes me (!) -- had given up on the sector!
Tab for Mortgage Mess
The foreclosure chaos could cost U.S. lenders $2 billion for every month that home seizures are delayed.
Today, FBR Capital's Paul Miller says that the tab for the foreclosure chaos could cost U.S. lenders $2 billion for every month home seizures are delayed.
Goldman Sachs, based on a continuation of QE and lower real interest rates, has raised its 12-month price target for gold to $1,650 an ounce from the prior forecast of $1,365.
Goldman's three- and six-month gold price forecasts now stand at $1,400 an ounce and $1,525 an ounce, respectively.
China Puts a Dent in World Equity Markets
China surprised the world's markets by raising reserve requirements for six commercial banks.
This put a dent in the world equity markets overnight.
long INTC
INTC "Better Than Expected," But The Next Day Always Tells The Tale With Them......
We had a bit of a roller-coaster ride today. Market players looked ready to take some profits this morning as earnings kicked off, but talk about QE II bailed out the bulls once again. We have heard so much about QE II lately that you can't help but wonder how many more times talk about it can cause us to spike up, but we obviously haven't hit the limit yet.
Big-cap technology stocks led the action today, with AAPL, AMZN and GOOG doing well. The cloud-computer and storage plays also bounced, which helped the Nasdaq 100 to substantially outperform the senior indices.
Breadth ended on a strong note, but volume was down a bit. Interestingly, renewed weakness in the dollar after the Fed served up QE II again didn't help gold, which was a laggard today. Oil and other commodities did reverse, but the key leadership was in financials, with names like GS making strong moves.
INTC is out tonight, and it was 'better than expected.' Everyone is well aware of the propensity of the stock to sell off on good news, so there may be some hesitancy to chase it.
Intel often sets the tone for earnings season, so it's a very important report, but it won't settle down until sometime tomorrow, so don't jump to any quick conclusions.
long AAPL; INTC
Big-cap technology stocks led the action today, with AAPL, AMZN and GOOG doing well. The cloud-computer and storage plays also bounced, which helped the Nasdaq 100 to substantially outperform the senior indices.
Breadth ended on a strong note, but volume was down a bit. Interestingly, renewed weakness in the dollar after the Fed served up QE II again didn't help gold, which was a laggard today. Oil and other commodities did reverse, but the key leadership was in financials, with names like GS making strong moves.
INTC is out tonight, and it was 'better than expected.' Everyone is well aware of the propensity of the stock to sell off on good news, so there may be some hesitancy to chase it.
Intel often sets the tone for earnings season, so it's a very important report, but it won't settle down until sometime tomorrow, so don't jump to any quick conclusions.
long AAPL; INTC
Dividend Capture
Here are my philosophical underpinnings of dividend-capture trading.
The challenge is the perceived "normal" behavior of stocks: Theoretically, they are supposed to drop by the dividend amount on the ex-dividend date. It turns out this is far from normal, and most stocks will trade back to their pre-dividend price in a short period of time.
This observation is why dividend capture can work, if executed effectively. If dividend payers were efficiently priced, they would drop by the amount of the dividend on the ex-date, then spend three months (or at least some very long time period) working their way back to the pre-dividend price. Reality is far different, fortunately. I researched the behavior of dividend-paying stocks and discovered that the majority went back to their pre-dividend price within two weeks of the ex-date. Even in the 2000-2002 bear market, 60% to 70% of stocks bounced back within a couple weeks.
Keep in mind that the two-week period was chosen arbitrarily. Extending it to one month enables even more stocks to bounce back. The challenge in dividend-capture trading is to avoid the one-third of stocks that do not bounce back. Of course, over time you will always be caught with a few of these. The successful dividend-capture trader will minimize both the bad picks and the magnitude of losses when a pick does go bad. Obviously, this is no different from one's efforts in regular capital gain trading.
I usually give myself a couple of weeks to a month to get back to even. I typically don't buy very close to the ex-date. Dividend stocks often spike right into the dividend, as Bristol-Myers did on September 28, for example.
Hazards on the Course
Part of understanding the strategy is to study dividends to avoid. One to possibly avoid last week was NLY. Despite (or because of?) a gigantic dividend of nearly 4%, I passed on this one. There is still substantial risk in the mortgage space, and the high yield indicates that the market does not believe in the sustainability of the dividend. The trade very well might work, but I simply don't want to take the risk. Generally, I target stocks in which the dividend payment is between 0.75% and 1.5%. More on the rationale for this range in the future.
The challenge is the perceived "normal" behavior of stocks: Theoretically, they are supposed to drop by the dividend amount on the ex-dividend date. It turns out this is far from normal, and most stocks will trade back to their pre-dividend price in a short period of time.
This observation is why dividend capture can work, if executed effectively. If dividend payers were efficiently priced, they would drop by the amount of the dividend on the ex-date, then spend three months (or at least some very long time period) working their way back to the pre-dividend price. Reality is far different, fortunately. I researched the behavior of dividend-paying stocks and discovered that the majority went back to their pre-dividend price within two weeks of the ex-date. Even in the 2000-2002 bear market, 60% to 70% of stocks bounced back within a couple weeks.
Keep in mind that the two-week period was chosen arbitrarily. Extending it to one month enables even more stocks to bounce back. The challenge in dividend-capture trading is to avoid the one-third of stocks that do not bounce back. Of course, over time you will always be caught with a few of these. The successful dividend-capture trader will minimize both the bad picks and the magnitude of losses when a pick does go bad. Obviously, this is no different from one's efforts in regular capital gain trading.
I usually give myself a couple of weeks to a month to get back to even. I typically don't buy very close to the ex-date. Dividend stocks often spike right into the dividend, as Bristol-Myers did on September 28, for example.
Hazards on the Course
Part of understanding the strategy is to study dividends to avoid. One to possibly avoid last week was NLY. Despite (or because of?) a gigantic dividend of nearly 4%, I passed on this one. There is still substantial risk in the mortgage space, and the high yield indicates that the market does not believe in the sustainability of the dividend. The trade very well might work, but I simply don't want to take the risk. Generally, I target stocks in which the dividend payment is between 0.75% and 1.5%. More on the rationale for this range in the future.
Monday, October 11, 2010
Thoughts
It Ain't Broke...
Mr. Market bended a bit today -- but didn't break.
Mortgage-Gate Could Swing Wide
If extended beyond the next month or two, mortgage-gate could be disruptive to the broader economy and stock market.
My conclusion?
Mortgage-gate reminds me of when the GS controversy began. Whether justified or not, it blew up out of proportion and permanently impaired Goldman's reputation and profitability.
Mortgage-gate, if extended beyond the next month or two (which, given the 40-state attorneys general agenda, seems possible) has implications well beyond the housing cycle; it holds the potential of being disruptive to the broader economy and even to the U.S. stock market.
What a toxic combination of fundamentals, sentiment and policy the banking industry faces.
* populist rhetoric and regulation;
* limited loan demand;
* mortgage-gate, which squelches housing activity through the end of the year and generally reduces the availability of mortgage credit;
* an hospitable and cheap public debt market that allows the well-financed companies to bypass commercial loans;
* a flat yield curve;
* quantitative easing;
* industry capital constraints; and
* a low level of absolute interest rates.
The timing of the banking industry's profit recovery has been delayed, and its earning power (and dividend paying ability) has been reduced.
Risk to the Downside Grows
Given the sharp rise in equities, the downside risk may soon lie at the highest level in a year.
Investors and traders are cheering for more bad economic news so, as the logic goes, the Fed must monetize more assets, even though the strategy has been innocuous. This is like Detroit Lions fans cheering for losses so they can get another high draft pick, even though they have been getting high draft picks for years, and it has had no beneficial effect for the team.
-- Bill King, The King Report
As we begin the final quarter of 2010, let's start by reviewing how both the bulls and the bears have erred in their strategic visions for this year:
* The bulls have underestimated the ability of the U.S. economy to sustain growth without an extreme Fed makeover and did not foresee the continued contraction in P/E multiples. Current low levels of manufacturing capacity utilization rates and an elevated unemployment rate were not in the Bulls' playbook a year, six months or even three months ago.
* The bears have underestimated the extent to which investors would go along with the Fed's ride and were willing to believe that the government can stimulate growth allowing the cycle to become self sustaining.
I have questioned the ultimate efficacy of further quantitative-easing measures. While the first round of quantitative easing produced "shock and awe" two years ago, QE 2 will likely produce "shucks and aww."
Most market participants are fixated with the potential for QE 2 to boost asset prices and generate organic economic growth, however, without a subsequent rise in aggregate demand and productivity, the program will ultimately be deemed a failure as prices readjust over time to reflect the real underlying fundamentals. Mr. Bernanke is making the same blunder that we made with the past bubbles busts -- if we can create paper profits and convince consumers that they should spend those paper profits, then we'll be on our way to economic prosperity. The problems arise when asset prices readjust lower to meet their true fundamentals. It's Ponzi finance and nothing more.
As I have previously explained, the goal of QE is to increase aggregate demand by creating a fictitious wealth effect and by increasing bank loans. The market appears to think that QE 1 was some sort of success, but as I have argued, QE 1 was only successful because it altered bank balance sheets and alleviated the credit strains. After all, this was Ben Bernanke's goal at the time -- to alleviate the credit pressures. What QE 1 did not do (and what we need now) is increase lending supported by a boost in real aggregate demand. QE does not add net new financial assets to the private sector and is not inherently inflationary, though Mr. Bernanke appears to be convinced otherwise. Unfortunately, QE 1 failed to succeed in contributing substantially to the economic recovery as Northern Trust recently showed.
-- "Northern Trust: QE 1 Failed, Why Will QE 2 Work?" from Pragmatic Capitalism
QE 2 (quantitative wheezing?) will not meaningfully move the needle of domestic economic growth and will only have a limited impact on:
* the jobs market, which is plagued by structural unemployment;
* housing, which that is haunted by a large shadow inventory of unsold homes and in which mortgage credit will likely be further reduced by the moratorium on foreclosures; and
* confidence, which is still mired in uncertainty regarding regulatory and tax policy (and that is undermined by high unemployment).
Meanwhile, our fiscal imbalances multiply, and our currency craters (and a worldwide rush to currency devaluation offsets some of the normal trade deficit benefit). There are a number of other possible adverse consequences from the inefficient allocation of resources that is the outgrowth of the next tranche of monetary stimulation.
The Federal Reserve seems determined to make mistakes. First, it started rumors that it would resume Treasury bond purchases, with the amount as high as $1 trillion. It seems all but certain this will happen once the midterm election passes. Then, the press reported rumors about plans to raise the inflation target to 4% or higher from 2%. This is a major change from the Fed's quick rejection of a higher target when the International Monetary Fund suggested it a few months ago.
Anyone can make a mistake, but wise people don't repeat the same one. Increasing inflation to reduce unemployment initiated the Great Inflation of the 1960s and 1970s. Milton Friedman pointed out in 1968 why any gain in employment would be temporary: It would last only so long as people underestimated the rate of inflation. Friedman's analysis is now a standard teaching of economics. Surely, Fed economists understand this.
Adding another trillion dollars to the bank reserves by buying bonds will not relax a constraint that is holding back spending. There is no shortage of liquidity in the economy -- banks already hold more than $1 trillion of reserves in excess of their legal requirements, and business balance sheets show an unprecedented amount of cash and near-cash assets. True, increasing bank reserves means mortgage rates will decline, at least temporarily; they already have in anticipation of the bond purchases. But neither the Fed nor the public should expect much stimulus as a result.
The most important restriction on investment today is not tight monetary policy but uncertainty about administration policy. Businesses cannot know what their taxes, health care, energy and regulatory costs will be, so they cannot know what return to expect on any new investment. They wait, hoping for a better day and an end to anti-business pronouncements from the White House. President Obama could do more for the economy by declaring a three-year moratorium on new taxes and new regulation.
-- Allan Meltzer, The Fed Compounds Its Mistakes, Wall Street Journal (op-ed)
The U.S. economic recovery remains fragile and is still characterized by excess industrial capacity and a surplus of labor. If we were in a sound and non-jeopardized economy, the Fed would not be having a QE 2 discussion nor would the administration be seeking extreme fiscal solutions. In my view we are in a contained recession, and while containment efforts continue, the efficacy of these efforts now appears to be waning.
While the immediate response to the likelihood of QE 2 has been to buoy asset prices, the domestic economy is stalling at around 1.5% to 2.0% GDP growth, and little improvement in the jobs market has been made. This hesitancy makes the slope of the recovery vulnerable to the unforeseen -- trade wars, policy errors and/or numerous tail risks from the last credit cycle (e.g., mortgage-gate).
To be balanced, I recognize that there are a number of factors that will insulate stocks from a meaningful drop. Among the positive considerations is that most discounted dividend models indicate value in equities (as interest rates are anchored at zero). Large corporations are flush with cash, are operating at record profit margins and face an inexpensive and hospitable bond market, which is supporting good dividend growth and robust buyback activity. Allocations into equities by institutional and retail investors remain muted. And, with mortgage rates plummeting, the consumer's debt service and balance sheet has improved more rapidly than anticipated.
Nevertheless, as I have written previously, I continue to see the risks to 2011 corporate profit and U.S. and worldwide economic growth rates to the downside. It remains likely that secular and nontraditional headwinds will produce an extended period of inconsistent and uneven growth in the years ahead -- difficult for both corporate managers and investment managers to navigate. Arguably, given the sharp rise in equities, the downside risk might be growing ever greater and may soon lie at the highest level than at any time over the last 12 months, especially if I am correct that QE 2 will be a dud.
More bad news for Microsoft.
More bad news for MSFT - C reduced the company's 2011 estimate by $0.05 a share as signs of a slowing consumer personal computer market continue to plague the company.
Mr. Market bended a bit today -- but didn't break.
Mortgage-Gate Could Swing Wide
If extended beyond the next month or two, mortgage-gate could be disruptive to the broader economy and stock market.
My conclusion?
Mortgage-gate reminds me of when the GS controversy began. Whether justified or not, it blew up out of proportion and permanently impaired Goldman's reputation and profitability.
Mortgage-gate, if extended beyond the next month or two (which, given the 40-state attorneys general agenda, seems possible) has implications well beyond the housing cycle; it holds the potential of being disruptive to the broader economy and even to the U.S. stock market.
What a toxic combination of fundamentals, sentiment and policy the banking industry faces.
* populist rhetoric and regulation;
* limited loan demand;
* mortgage-gate, which squelches housing activity through the end of the year and generally reduces the availability of mortgage credit;
* an hospitable and cheap public debt market that allows the well-financed companies to bypass commercial loans;
* a flat yield curve;
* quantitative easing;
* industry capital constraints; and
* a low level of absolute interest rates.
The timing of the banking industry's profit recovery has been delayed, and its earning power (and dividend paying ability) has been reduced.
Risk to the Downside Grows
Given the sharp rise in equities, the downside risk may soon lie at the highest level in a year.
Investors and traders are cheering for more bad economic news so, as the logic goes, the Fed must monetize more assets, even though the strategy has been innocuous. This is like Detroit Lions fans cheering for losses so they can get another high draft pick, even though they have been getting high draft picks for years, and it has had no beneficial effect for the team.
-- Bill King, The King Report
As we begin the final quarter of 2010, let's start by reviewing how both the bulls and the bears have erred in their strategic visions for this year:
* The bulls have underestimated the ability of the U.S. economy to sustain growth without an extreme Fed makeover and did not foresee the continued contraction in P/E multiples. Current low levels of manufacturing capacity utilization rates and an elevated unemployment rate were not in the Bulls' playbook a year, six months or even three months ago.
* The bears have underestimated the extent to which investors would go along with the Fed's ride and were willing to believe that the government can stimulate growth allowing the cycle to become self sustaining.
I have questioned the ultimate efficacy of further quantitative-easing measures. While the first round of quantitative easing produced "shock and awe" two years ago, QE 2 will likely produce "shucks and aww."
Most market participants are fixated with the potential for QE 2 to boost asset prices and generate organic economic growth, however, without a subsequent rise in aggregate demand and productivity, the program will ultimately be deemed a failure as prices readjust over time to reflect the real underlying fundamentals. Mr. Bernanke is making the same blunder that we made with the past bubbles busts -- if we can create paper profits and convince consumers that they should spend those paper profits, then we'll be on our way to economic prosperity. The problems arise when asset prices readjust lower to meet their true fundamentals. It's Ponzi finance and nothing more.
As I have previously explained, the goal of QE is to increase aggregate demand by creating a fictitious wealth effect and by increasing bank loans. The market appears to think that QE 1 was some sort of success, but as I have argued, QE 1 was only successful because it altered bank balance sheets and alleviated the credit strains. After all, this was Ben Bernanke's goal at the time -- to alleviate the credit pressures. What QE 1 did not do (and what we need now) is increase lending supported by a boost in real aggregate demand. QE does not add net new financial assets to the private sector and is not inherently inflationary, though Mr. Bernanke appears to be convinced otherwise. Unfortunately, QE 1 failed to succeed in contributing substantially to the economic recovery as Northern Trust recently showed.
-- "Northern Trust: QE 1 Failed, Why Will QE 2 Work?" from Pragmatic Capitalism
QE 2 (quantitative wheezing?) will not meaningfully move the needle of domestic economic growth and will only have a limited impact on:
* the jobs market, which is plagued by structural unemployment;
* housing, which that is haunted by a large shadow inventory of unsold homes and in which mortgage credit will likely be further reduced by the moratorium on foreclosures; and
* confidence, which is still mired in uncertainty regarding regulatory and tax policy (and that is undermined by high unemployment).
Meanwhile, our fiscal imbalances multiply, and our currency craters (and a worldwide rush to currency devaluation offsets some of the normal trade deficit benefit). There are a number of other possible adverse consequences from the inefficient allocation of resources that is the outgrowth of the next tranche of monetary stimulation.
The Federal Reserve seems determined to make mistakes. First, it started rumors that it would resume Treasury bond purchases, with the amount as high as $1 trillion. It seems all but certain this will happen once the midterm election passes. Then, the press reported rumors about plans to raise the inflation target to 4% or higher from 2%. This is a major change from the Fed's quick rejection of a higher target when the International Monetary Fund suggested it a few months ago.
Anyone can make a mistake, but wise people don't repeat the same one. Increasing inflation to reduce unemployment initiated the Great Inflation of the 1960s and 1970s. Milton Friedman pointed out in 1968 why any gain in employment would be temporary: It would last only so long as people underestimated the rate of inflation. Friedman's analysis is now a standard teaching of economics. Surely, Fed economists understand this.
Adding another trillion dollars to the bank reserves by buying bonds will not relax a constraint that is holding back spending. There is no shortage of liquidity in the economy -- banks already hold more than $1 trillion of reserves in excess of their legal requirements, and business balance sheets show an unprecedented amount of cash and near-cash assets. True, increasing bank reserves means mortgage rates will decline, at least temporarily; they already have in anticipation of the bond purchases. But neither the Fed nor the public should expect much stimulus as a result.
The most important restriction on investment today is not tight monetary policy but uncertainty about administration policy. Businesses cannot know what their taxes, health care, energy and regulatory costs will be, so they cannot know what return to expect on any new investment. They wait, hoping for a better day and an end to anti-business pronouncements from the White House. President Obama could do more for the economy by declaring a three-year moratorium on new taxes and new regulation.
-- Allan Meltzer, The Fed Compounds Its Mistakes, Wall Street Journal (op-ed)
The U.S. economic recovery remains fragile and is still characterized by excess industrial capacity and a surplus of labor. If we were in a sound and non-jeopardized economy, the Fed would not be having a QE 2 discussion nor would the administration be seeking extreme fiscal solutions. In my view we are in a contained recession, and while containment efforts continue, the efficacy of these efforts now appears to be waning.
While the immediate response to the likelihood of QE 2 has been to buoy asset prices, the domestic economy is stalling at around 1.5% to 2.0% GDP growth, and little improvement in the jobs market has been made. This hesitancy makes the slope of the recovery vulnerable to the unforeseen -- trade wars, policy errors and/or numerous tail risks from the last credit cycle (e.g., mortgage-gate).
To be balanced, I recognize that there are a number of factors that will insulate stocks from a meaningful drop. Among the positive considerations is that most discounted dividend models indicate value in equities (as interest rates are anchored at zero). Large corporations are flush with cash, are operating at record profit margins and face an inexpensive and hospitable bond market, which is supporting good dividend growth and robust buyback activity. Allocations into equities by institutional and retail investors remain muted. And, with mortgage rates plummeting, the consumer's debt service and balance sheet has improved more rapidly than anticipated.
Nevertheless, as I have written previously, I continue to see the risks to 2011 corporate profit and U.S. and worldwide economic growth rates to the downside. It remains likely that secular and nontraditional headwinds will produce an extended period of inconsistent and uneven growth in the years ahead -- difficult for both corporate managers and investment managers to navigate. Arguably, given the sharp rise in equities, the downside risk might be growing ever greater and may soon lie at the highest level than at any time over the last 12 months, especially if I am correct that QE 2 will be a dud.
More bad news for Microsoft.
More bad news for MSFT - C reduced the company's 2011 estimate by $0.05 a share as signs of a slowing consumer personal computer market continue to plague the company.
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