It's been hard to escape the bullish news lately. The bears seem all but extinct.
Here's a quick rundown of where we stand...
- The S&P 500 is closing in on a new 52-week high.
- The Dow is closing in on its October 2007 all-time high.
- The iShares MSCI Emerging Markets Index is up about 20% from its 52-week low.
- The market's "fear index," the VIX, is at its lowest point since January 2007.
- The yield on the 10-year T-note recently broke above 2% for the first time since January 2012.
- Gold is down about 8% from its 52-week high.On the surface, the bull case seems rock solid. Stocks are up. "Safe haven" Treasury bonds and gold are slipping. And the ultra-low VIX reading indicates that investors are no longer worried about stocks crashing any time soon. (Values below 20 generally correspond to times of low volatility and market stress.)
I wouldn't get too excited just yet. The recent bull run is starting to look vulnerable to a correction.
The Federal Reserve bank remains the 800-pound gorilla in the room. It has pumped $2.1 trillion in the system since the collapse of Lehman Brothers in 2008. And according to a recent survey of economists by Bloomberg, it will pump in at least another $1 trillion.
This has clearly lifted stock prices. There is now an 85% positive correlation between the direction of the S&P 500 and the size of the Fed's balance sheet. In other words, stocks are moving in almost perfect lockstep with Fed money printing.
The problem is the Fed isn't able to do a thing about contracting economic growth. And eventually, this will hit corporate profits – already 70% above the historic norm – and therefore stock prices.
In case you missed it, U.S. GDP growth shrank by an annual rate -0.1% rate in the fourth quarter – well below the consensus estimate of a +1.5% expansion in growth.
Whisper it. But the U.S. economy was in "recession" in the last quarter.
So, why the gloomy GDP report? Simply put, the effects of Washington's austerity are starting to make themselves felt. Government spending cuts (mostly in defense) posed a 130 basis point drag on growth in the recent report.
And yes – we saw some of the effects of hurricane Sandy in the numbers. But this does little to explain the big gap between the +1.5% consensus view and the actual shrinkage in the economy, as economists were already factoring in the Sandy factor.
As I warned members of our top-tier investment services Bonner & Partners Family Office and Bonner & Partners Private Wealth at the end of last year, austerity in the U.S. will be a serious headwind for markets in 2013. Here's what I wrote in a private briefing to paid-up members of these services:
Whether we fall off the "fiscal cliff" or not, there is certainly no more fiscal stimulus on the table. Some combination of tax hikes and spending cuts will act as a further brake on growth.
And it is exactly this effect that we are now seeing reflected in the recent quarterly GDP figures. We may have had a grand deal from Congress over the "fiscal cliff"… but half a cliff is still a big problem for an already anemic economy.
This is a truly fascinating situation. On the one hand you have a big surge in stocks. On the other, you have slowing economy.
In other words, the bulls may have the Bank of Bernanke onside. But the real economy is still a mess. If you are defensively positioned in your portfolio, I recommend you stay that way. If you've been betting heavy on the recent stock surge, now may be a good time to take some profits off the table.
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