Stocks are soaring today on a coordinated effort by global central banks to flood the banking system with money. While it may seem like great news for investors, this rally in equities shouldn't be trusted.
Central banks announced Wednesday that they were lowering the costs on dollar swaps. Essentially, these swap lines improve liquidity conditions in U.S. and foreign financial markets "by providing foreign central banks with the capacity to deliver U.S. dollar funding to institutions in their jurisdictions during times of market stress," according to the Federal Reserve .
With foreign bank stocks sitting on shaky ground due to their exposure to the European debt crisis, the dollar-swap lines are a life raft. And the announcement was good enough to push Dow Jones Industrial Average higher by nearly 400 points, or 3.4 percent, minutes after the opening bell. Similarly, the S&P 500climbed 39 points, or 3.2 percent, and the Nasdaq jumped 75 points, or 3 percent.
Bank stocks were surging on the announcement. Bank of America, Citigroup, Morgan Stanley, Goldman Sachs and JPMorgan Chase rose between 3.9 percent and 6.2 percent.
What's great for the banks isn't so good for everyone else, though. Investment strategists already are noting the desperation of the move, adding that flooding the banking system with liquidity doesn't do anything to solve the real problem of ballooning, unmanageable debt levels.
"It doesn't solve the overall problem," says Robert Pavlik, chief investment officer with Banyan Partners in New York. "Even if they are able to stabilize the banks in Europe, they're almost prevented from lending because of capital requirements, the unwinding of assets and the austerity measures. It'll be like what we saw in the U.S. a few years ago where they got cheap money but never lent out any of it."
Paul Nolte, managing director at Chicago-based Dearborn Partners, says this is just another stop gap that kicks the proverbial can down the road.
"Debt is the overarching issue. What occurred today does nothing to reduce levels of debt. It just shifts it different holders," Nolte says. "In the short run, the liquidity is a wonderful thing. But in the long run, you have to repay it in some fashion."
How is this liquidity going to get sopped up in the future? That's the main question investors should be considering as they look beyond the headlines. The money has to come from somewhere, and the answer isn't something investors already worried about the debt crisis will want to hear.
"All we are doing is shifting the debt load from the banking side to the general public," Nolte says. "It assumes that we're going to have growth sufficiently high enough that we can generate the dollars to do that. There is, so far, nothing that indicates that will be the case."
The news of the coordinated effort by central banks is but one headline that is being misinterpreted this morning. China announced earlier that it would cut the reserve requirementsfor banks, news that turned stock futures higher. Again, the investment managers question why stocks would rally on what actually looks to be bad news.
"China is facing a situation, if you read behind the lines, they're cutting because they're getting nervous about growth and the strength of their economy," Pavlik says.
So what should investors and traders do today given the massive rally in equities? Sit back and enjoy the ride, but don't bother trying to get on board now.
"If you're invested, let them run, don't chase them," says Pavlik. "Right now, you have to take it day to day. If you're longer-term, don't get wrapped up in this. If you're a trader, let your winning trades move on and be ready. This market is poised for some type of whipsaw action. That's very short-term."
Nolte, meanwhile, says that nothing has changed much from the perspective that you want to buy quality companies at a reasonable price. "Pick your points to buy and sell and don't worry about it," he says. "Unfortunately, since August we've seen the volatility on both sides but we haven't gone anywhere. The world was coming to an end last week and now the world is being put back together."
Investors did get a dose of good news Wednesday on the U.S. economy. The ADP Employment Report showed that the economy added 206,000 jobs in November, a higher number than expected. In addition, the Chicago Purchasing Managers Index, a measure of manufacturing activity in the Midwest, came in at a better-than-expected 62.6.
Even so, investors may be forgetting some of the bigger problems in the global economic environment. Unemploymentin the U.S. and in Europe is stubbornly high, gross domestic product in Europe and China is shrinking with some eurozone countries on the brink of a recession, and the political system in the U.S. appears completely broken heading into a presidential election year in 2012.
"The economic news in the U.S. is OK, and that's as far out on the boards I'm willing to go," Nolte says. "It's actually poor if you realize it's the second or third year of an economic recovery. We've yet to get unemployment under 9 percent. We've yet to get GDP up over 3 percent. That's not good and it means it's going to be slow going for a long time."
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