Stocks Hit a Wall—And May Need the Fed After All
Stocks have a hit wall since the dour economic warning from Ben Bernanke earlier this week, and the Fed chairman may be one who has to get the market to the other side.
A rally that took the major averages up more than 25 percent since October has fizzled over the past two weeks in part because of an unfettered rise in gasoline pricesas well as general concerns that the economic recovery may have seen its biggest advances.
The 3 percent economic growththe government reported Thursday for 2011's fourth quarter is likely to represent the high-water mark for gross domestic product well into 2013, according to most economic forecasts.
So when Bernanke said in well-publicized remarks on Monday that he worries that the employment picture will be muddied going forward, it gave impetus to the notion that the central bank will have no choice but to step in with more stimulus.
"The recent data points to the potential for a plateau in economic activity, which has been clearly flagged by fourth-quarter GDP data exhibiting signs of a lack of substance behind a spurt in output," says Andrew Wilkinson, chief economic strategist at Miller Tabak in New York.
"It won’t take many days of stock market selling and a slide to 2 percent on benchmark yields before investors figure out just how much the economy needs ongoing stimulus from the central bank," he adds.
Wilkinson rejects the notion that the economy is well enough to grow on its own, and advocates that the Fed will need to continue its unprecedented levels of money creation — through quantitative easing — and zero interest rates to keep growth alive.
Bernanke's "policies have likely arrested the firing of workers over the past couple of years, which is why he expresses significant concerns about labor market data and therefore the robust appearance of the recovery," Wilkinson said. "The Fed is not stupid and recognizes both resource and labor capacity is significantly large and likely to remain so for long enough to permit not only existing policy ease, but also fresh stimulus."
The Fed chief's problem is that critics worry that the inflow of liquidity — the central bank's balance sheet is about $2.88 trillion — along with the low interest rates will create inflation , which has shown up in the all-important food and energy prices but otherwise has been relatively tame.
In a presidential election year, Bernanke will have to choose his actions even more carefully. But if the markets continue to falter and inflation holds at bay, the path to another round of easingbecomes clearer.
"They're already in way over their heads and there's a problem going to develop from all this," says Rob Lutts, president and chief investment officer at Cabot Money Management in Salem, Mass. "Thanks to global central bankers continuing to flood us with liquidity and stimulating economies beyond what's reasonable, they need to have the stock market rally to pull us out of this."
For investors, the best plays may be to ride what Lutts sees as bubbles both in the stockand gold markets.
"Nobody knows the ramifications from all of this," he says. "I'm very confident of one conclusion: Your dollar and major developed economies' currencies are going to be debased substantially. So think about real assets."
Despite the allure of stocks and commodities due to the weakened dollar, investors have continued to pour money into bonds, which have massively underperformed riskier assets this year.
The first quarter of 2012 has seen the largest nonfinancial corporate bond issuance on record at $255.5 billion, a 9 percent increase over the same period a year ago, according to Dealogic.
Such a large issuance could drive down prices and push up yields .
Returns on corporate debt have been modest this year, with the iShares iBoxx Investment Grade Corporate Bond exchange-traded fund up about 1.8 percent year to date.
Its high-yield counterpart has fared even worse, bringing back just 1.5 percent.
But investors whose portfolios have gone out of their 60-40 stocks-to-bonds percentage allocation because of the rise in equities may be forced to look for fixed income offerings to rebalance.
"There are plenty of reasons to have the market pause at the psychological (Standard & Poor's 500) level of 1,400, and people are finding those reasons," says Paul Zemsky, head of asset allocation at ING Investment Management in New York. "Some are rebalancing out of equities if you want to stay at the 60-40 mix. Lots of little reasons can add up to a few percentage points, but nothing more than that."
Zemsky said his firm has been taking profits lately but remains overweight on stocks. Bernanke, he says, probably was just telling the market "that he has more tools if the economy does slow down."
"We're watching tons of fundamental indicators to try and discern if (the economic growth is going to stop). Pretty much all are telling us it is not," he says. "All the fundamental indicators are telling us we're in for consistent, moderate growth."