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The week running up to Easter ended with a punk jobs report that punctuated a first quarter filled with a stream of consistently bad economic data.
March nonfarm payrolls grew by only 126,000, far below consensus estimates of 225,000. Worse, 69,000 jobs were subtracted from January's and February's tallies. The unemployment rate stayed at 5.5% only because the job participation rate jumped back up to its lowest level since 1978.
And while the cock-eyed optimists who are waiting for the economy and the markets to reach escape velocity like Vladimir and Estragon are still waiting for Godot were rushing to blame the number on the weather, the government reported that 182,000 people reported they couldn't get to work because of the weather in March – in line with historical norms.
It isn't the weather that is hurting the economy…
It is the strong dollar and the crushing weight of debt that are preventing businesses from hiring new workers, building new factories, and starting new R&D projects. Instead, they are buying back their own stock to prop up their own stock prices and holding on for dear life.
No, Really. The Fed Is Robbing You…
Stocks were basically flat on the holiday-shortened week, with the Dow Jones Industrial Average (INDEXDJX:.DJI) and S&P 500 (INDEXSP:.INX) both up 0.29% and the NASDAQ Composite (INDEXNASDAQ:.IXIC) down -0.09%.
Futures were down sharply on Friday when the markets were closed, however, so the opening on Monday could be ugly. In sharp contrast, the bond market rallied after the March jobs report, driving the yield on the benchmark 10-year Treasury bond down to 1.81%.
Investors are moving back their estimates of when the Fed will raise rates to September from June, and more are arguing it won't happen until much later this year if at all in 2015.
The only certainty with respect to what the Fed will do is that they will screw things up. It should have raised rates a long time ago. Low rates are no longer boosting the economy; they are holding the economy back by reducing the incentives for banks to lend to productive projects and depriving savers of a just return on their capital.
Zero interest rates have reduced the cost of funds for the $15 trillion U.S. banking system from roughly $500 billion to only $50 billion annually, depriving savers of $450 billion of annual interest income. This policy is contributing to sluggish income growth and will ultimately make it impossible to justify current asset prices.
A Happy Ending Isn't on the Cards
Either the Fed will start raising rates, and markets will react, or the Fed will feel it has to wait because the U.S. economy is too weak to handle higher rates. Either way, it is difficult to see a positive trajectory for the stock market in the period ahead.
With first quarter GDP expected to come in close to 0%, and S&P 500 earnings estimates continuing to fall due to a combination of lower oil prices and dollar strength, the outlook for equities remains muted.
Goldman Sachs maintains a year-end S&P 500 target of 2100, 2% higher than the index's current level. Valuations are extended with the forward earnings multiple at 18x and other measures such as the S&P 500 Market Cap/GDP and Shiller Cyclically Adjusted P/E Ratio at well above historical averages.
The models of highly respected market strategists like Rob Arnott at Research Affiliates and Jeremy Grantham at GMO project 0-2% 10-year returns for both U.S. stocks and bonds. Investors are going to have to find very skilled managers or unique alternative strategies to flourish in the next decade. Those counting on continued stock market gains supported by Fed-liquidity are going to be very disappointed.
Investors Need to Understand This
While U.S. stocks were mixed in the first quarter, the real action was in Europe and Asia where markets skyrocketed in both local currency and dollar terms. In the first three months of 2015, the S&P 500 ground out a 1% total return (price plus dividends) while the Dow Jones Industrials lost 2% and the Nasdaq gained 3.5%.
In contrast, the German DAX soared by 22%, its best performance since its creation in 1988, and the FTSE Eurofirst 300 Index (INDEXFTSE:.E3X) climbed by 16%, boosted by the European Central Bank's QE program and the collapse of the euro from $1.20 to $1.07 during the same period.
The MSCI Asia Pacific Index soared by 7% during the quarter also driven by expectations of further monetary easing in Japan and China. Unhedged dollar investors enjoyed lower but still high single digit returns that blew away their investments in the U.S.
The markets are telling a story that investors need to understand.
That story is that the only growth that is occurring in the global economy is coming from central banks keeping interest rates at zero (or below zero in Europe where $3 trillion of debt now trades there) reducing the value of their currencies.
European and Asian markets are not rallying because of robust organic growth in those regions. They are rallying because companies in those regions – primarily exporters – are benefitting from cheaper currencies that allow them to sell more goods abroad.
In the U.S., companies are buying back massive amounts of stock (though there is currently a seasonal lull tied to the earnings season that will likely result in stock market weakness) financed with low cost debt that allows them to artificially pump up their earnings without having to grow them.
Junk bond borrowers are not generating enough free cash flow to repay their debt but aren't defaulting on those debts because their borrowing costs are extremely low. Moody's is forecasting a 2.9% default rate in 2015, far below the 4.5% norm of the last 20 years.
The story is that the global economy is addicted to low interest rates and cheap currencies, not that that it is growing organically or productively.
There is a race between the incredible innovation in digital technology that is shaking the world and the dead weight of debt and brain-dead economic policies that are threatening to push the global economy into another financial crisis.
Add to that race the most unstable geopolitical situation in nearly a century and investors should be battening down the hatches, not chasing stock prices higher.
It is a story that is going to have a very sad ending for those who fail to understand it.
About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.