Above consensus payroll numbers extended gains in equities as hope continued to spring eternal on Opening Day. Although, it was the first day of what is traditionally, a month associated with bullish seasonality, there is cause for concern that Mr. Market may be pulling an April Fool's joke on all the bulls. The rally continues to be on waning volume and flat open interest, while the bond market appears to be pricing in an end to QE2, as the yield curve continues to flatten in expectation of the Fed’s need to control inflation.
An end to QE2 followed by a Fed tightening would raise short term rates and as inflation concerns abated, long term rates would fall, flattening the curve even more. While we have only one marker to compare where the Fed cut back on quantitative easing, the results are not confidence inspiring for the bulls. Post QE1, the S&P dropped from 1217 down to 1064, and commodities and crude were also hit hard, while rates rose. Is the economy strong enough this time around, to continue it’s “growth” without stimulus? Or does the Fed, extend the easing cycle with QE3 and we see $150.00 crude and $5+ gas at the pumps this Summer? I'm betting on the former, which is going to make me ever so vigilant of the possibility, that this April's market could be a contra-seasonal one.
That being said, QE2 may end in June, but the Fed’s near ZIRP may continue ad infinitum, or at least until inflation is actually the result of income growth and economic growth instead of monetary policy. In the meantime, equities are still a better place to be than cash, and the real momentum chasing may still be forthcoming in April. If the powers-that-be can manipulate an entire market, and engineer one of the greatest bull market rallies of all time, during a time when the economic fundamentals have been absolutely horrid, and global headline news is about one disaster after another, then yes, they just might be able to perpetuate the current asset inflation a little while longer.
Nevertheless, Keynesian money printing/credit creation has been substituted for actual wealth creation, once again. And just like before, it has led led to massive debt across private and public sectors, as nominal income not only remains flat, but in real terms is contracting at a 2.3% annual rate. True, corporate profits are up and are close to all-time highs as a percentage of GDP, but this does not necessarily reflect a robust economic recovery. Strong control over the balance sheet and cheap labor costs due to wage concessions and layoffs, has resulted in lower unit labor costs and higher productivity. While there has been an extraordinary recovery in corporate profits, top line growth has not been spectacular, and bottom line growth has not led to job creation.
When QE2 ends, and the business cycle returns to normal, logic dictates that profits will revert back to their mean, leaving nowhere for valuations to go, but down. The Fed can only use the “forward looking” rationale for so long, before the laws of supply and demand catch up, and mete out economic justice, once again.
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