Saturday, September 16, 2006

Federal Reserve is Driving the Stock Market

You’ve probably wondered – if there is so much negative economic data out there – why does the stock market continue to rise? With the Dow Jones Industrial Average and S&P 500 index up by significant percentages this year – it would seem that stock investors know something we don’t. Is this true or is something else happening?

If you invest in stocks, then you are familiar with the stock price to earnings ratio. This is a good metric to determine if a stock price is considered expensive – and therefore, a good metric to determine whether or not to buy a particular stock (P/E trends). If we take this a step further and look at the P/E ratio for the entire S&P 500 index – we can get a good idea if it’s a good time to buy into the stock market.

So - there are two, very big questions we should answer when it comes to future stock prices:

1. Is the economy rebounding to the point that company earnings will increase significantly in coming quarters?

2. Are stock prices considered high compared to corporate earnings?

As I’ve said before – I see no indication (based on good, quantitative economic data) that the economy is rebounding. As we’ve seen – the economy continues to deteriorate – continuing job losses, growing residential and commercial loan defaults, home prices continue to decline, wages and income declining, etc. Therefore, I would not bet my financial future on a quick economic turnaround that will increase corporate earnings - based on the economic data that I trust.

Also remember, companies have been able to beat recent earnings estimates due to significant cost reductions – not due to sales/revenue increases. How much more can they cut if revenues continue to decline? Bottom line – I would not expect to see a significant turnaround in corporate earnings any time soon.

This is not exactly good news considering current S&P 500 earnings. Over the past 20 months we’ve watched the biggest earnings drop in the history of the S&P 500. Again, you’re probably wondering – with such a big drop in earnings – why is the S&P 500 up approximately 35% since March? Good question. We’ll answer it after we look at the current S&P 500 P/E ratio.


With earnings plunging, we would expect to see a high P/E ratio if prices haven’t also plummeted. As I mentioned above, since S&P 500 stock prices have increased significantly since March – the S&P 500 P/E ratio is through the roof.
From Nathan’s Economic Edge (http://economicedge.blogspot.com/):
“The higher stocks go without real earnings and without clearing the debts from consumers, the higher price to earnings ratios will go. It is ultimately earnings that underpin the equity markets and the price of stocks has NEVER been so high compared to earnings.

It would take one heck of a lot of growth to pull P/E’s back into a normal historic range, and the only reason they look as “good” as they do is because the financial industry was allowed to go back and mark their assets to fantasy – otherwise the large banks are still insolvent and would not have earned a nickel.”
The answer to question #2 is – stock prices are at historic highs compared to earnings – and not by a small margin. We see the same situation with the DJIA.
Bottom line – we see no real economic turnaround and P/E ratios are at historic highs. What does this tell you? It tells you that it’s a very bad time to invest in the stock market. If you’re not in the market – stay out. If you’re in – get out. The whole house of cards could collapse at any time.
So – the final question to answer is – why are stocks increasing if the economy and earnings are plummeting? It’s not because the economy is rebounding (regardless of what the media tells us) and it’s not because stocks are cheap. As Chris Martenson shows us below – the culprit is – once again - the Federal Reserve.
If you’ve seen the movie ‘The Sting’ (1973), you have some knowledge of how a confidence (con) scheme works. In the movie, Robert Redford and Paul Newman’s characters ‘con’ a big time bad guy (the ‘mark’) out of some serious money. The ‘con’ was broken down into the following acts:
1. ‘The Set Up’ – devise a plan to deceive and then steal a significant amount of money from the ‘mark’
2. ‘The Hook’ – create a situation that ‘hooks’ your ‘mark’ – meaning that the ‘mark’ becomes very interested in what your scheme can do for him
3. ‘The Tale’ – tell a good story that the ‘mark’ believes will make him lots of money. A good tale preys upon the weaknesses of the ‘mark’.
4. ‘The Sting’ – just when the ‘mark’ thinks he’s going to make a killing – pull the rug out from under him and steal his money
What was the most important lesson from this movie? The ‘mark’ can never know that he’s been taken.
The people of the United States have been the victim of the biggest confidence scheme in the history of the world.
By creating bank panics in the late 19th/early 20th centuries, the bankers behind the Federal Reserve set the stage for the Federal Reserve Act of 1913.
We’ve been told a grand tale – that our current banking system is stable, reliable and benefits everyone.
We’re about to experience the ‘Sting’ – when the international bankers behind the Federal Reserve try to take everything from us. This will most likely begin in earnest with a significant stock market crash.
With high stock prices, low corporate earnings and a deteriorating economy – our stock markets have been setup for an historic fall.
It’s going to be epic.
jg – August 7, 2009

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Fed POMO activity and the Stock Market
Friday, August 7, 2009, 11:38 am, by cmartenson

Today, again, we receive news that Fed is continuing to pour more and more POMO money into the banking system, this time with a 'mere' ~$2 billion addition.
August 7 - New York Fed purchases $1.937 billion in agency coupons
As long-time readers here know, I have been tracking the Permanent Open Market Operations (or "POMO") activity of the Fed for a long time.
As I wrote in The Five Horsemen ( May 31 2009, enrollment required $):
The beginning of the end for nearly every debt-ridden country has always been the attempt to pay for past expenditures with newly-minted money. It always starts innocently enough and seems like the right thing to do, but soon the programs grow and grow, and eventually the currency of the country is destroyed.
Now the Fed is openly and actively buying dodgy debt from the government as well as from the private sector. I covered on this in May (2009) in an "In Session" posting, where I charted the amount of US Treasury debt that was being purchased by the Federal Reserve on a daily basis.

This chart reflects only the Treasury purchases. When we add in agency debt, mortgage-backed securities, and various other corporate debt programs, we find that the Federal Reserve is printing up roughly $15 to $30 billion dollars a day just to keep things limping along.
As for the opening quote by Mises, which I think most accurately reflects how things will turn out, I think it is safe to say this: Any country that is printing up to $30 billion a day just to keep things moving along is not voluntarily abandoning credit expansion.
This means that we are risking a final catastrophe of the currency system involved. Unfortunately, the currency in question also happens to be the world's reserve currency, so this has enormous, far-reaching implications.
Today I want to update that chart above and provide a little more context by placing it beneath a scaled chart of the Dow Jones index (time periods match exactly so the charts align). Again, what you are looking at is a chart of POMO activity that is being expressed as "billions of dollars per day." No effort has been made to account for weekends or holidays; this is simply taking each POMO and dividing it by the number of days that pass until the next one.

What we might wonder here are three things:
1. How would the stock markets have behaved without the massive daily additions of billions of dollars?
2. When the stock market turned around in advance of the initiation of the POMO purchases which major bank holding companies, such as GS, were effectively front-running this flood of money?
3. If the stock market is up 40%+ and green shoots are everywhere, why is the Fed continuing to pour gasoline on the fire ($16 billion this week so far)?
Part of the answer may lie in a nice piece of work posted at ZeroHedge which notes that on POMO days that stock markets exhibited some statistically unlikely upward thrusts in the final few minutes of each associated trading day.
Under this scenario POMO money is being shuffled out of the endless thin-air vaults of the Fed and into the banking system where it needs to find something to do. One of those things, it seems, is to goose the stock market, especially late in the day.
The goal, we surmise, is simply to get the stock market to move upwards. This is not an unthinkable idea to me because, frankly, it is exactly the prescription I would write for an economy as dependent on rising asset prices as is the United States'. If a rising stock market helps to get people out buying and spending again then it is a worthy goal in many a policy-makers mind, I am sure.
The only question here is "what does this mean to me?" We'll be exploring that in some detail later on…

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