Is the jobs rally for real?
Wall Street's ability to surprise and confound was on display Friday after a better-than-expected November payroll report pushed the Dow Jones industrial average back into the stratosphere.
The strength of the job market was a surprise, mainly because both consumer spending and business investment have been soft lately. That weakness is a sign that the underlying economy lacks the robustness we'd all like to see.
But the market's reaction to the report was also a surprise, given that stocks have displayed a "good news is bad news" tendency lately. That's because coming into the report, the conventional wisdom was that a strong report would push the Federal Reserve to start pulling back its ongoing, open-ended $85 billion-a-month bond purchase program, dubbed "QE3" by the financial cognoscenti. And that would be bad news, since stocks have been much more dependent on the flow of the Fed's cheap money than underlying economic fundamentals.
Why is the taper on deck?
Well, for one, the third round of quantitative easing, as the policy is called, was first announced in September 2012 and is getting long in the tooth. That increases the risks of inflating asset bubbles, encouraging excessive risk-taking and losing its effectiveness. One indication that the Fed's bond purchases are running low on power -- growth in personal consumption expenditures has weakened during QE3.
Moreover, back in June Fed chairman Ben Bernanke himself fingered a 7 percent unemployment rate -- which the central bank didn't believe was feasible until sometime in mid-2014 -- as being the jobless rate that would prevail when QE3 ended. So here we are, with a jobless rate of 7 percent, and QE3 remains at full strength.
The Fed has also highlighted a 6.5 percent unemployment rate as being the threshold to start discussing an increase in short-term interest rates, which have been parked near zero percent since 2008. If the solid job-creation continues, we'll hit that threshold in six months.
Given that the Fed needs to protect its communication credibility -- and avoid the nasty side effects of excessive cheap-money stimulus, which let's not forget contributed to the run up to the 1929 stock market crash -- the bank's December 18 policy statement will likely feature a taper decision, some market watchers think. Other forecasters expect the Fed to start dialing down stimulus well into 2014.
When Bernanke first started talking taper in May, the bond market convulsed, stocks fell and investors were shaken out of their complacency. When a tapering decision looked inevitable in September, the Fed got cold feet and backed away.
Yet now, with tapering possibly less than two weeks away, stocks are on a tear higher as the Dow recapturing the psychologically important 16,000 level. But can the stock surge continue? Has the tapering been priced in, and now stocks are discounting better economic fundamentals?
It's possible. Although I would caution that there are a number of signs stocks are still vulnerable to a taper-related pullback later this month.
For one, investor sentiment is fragile. The ratio of bulls-to-bears in the Investor's Intelligence survey has extended to levels not seen since 1987. Investors in the Rydex family of mutual funds, according to Jason Goepfert of SentimenTrader, have never been this aggressively positioned before with money market fund assets (essentially cash) well below levels seen as the last bull market was peaking in 2007.
Also, market technicals are looking shaky. At press time, there were 1,413 net advancing issues on the New York Stock Exchange, well below the 2,200+ readings we saw back in October as the market was rising out of the debt-ceiling lows. And through Thursday, the relationship between new highs and new lows on the NYSE was breaking down to an extent not seen since the beginning of the August market pullback.
And let's not forget that job gains have yet to turn real-world measures of household health around in a meaningful way, including the labor participation rate, full-time employment and personal consumption expenditures.
The truth is, we've never been in a situation like this before where the market has become so very dependent on the Fed's monetary morphine -- a drip feed that's more aggressive now than it was at the height of the financial crisis in 2008. We don't know how the market, especially Treasury bonds, will react to a removal, albeit slow and cautiously, of that policy opiate.
I have a hard time believing the withdrawal will be as benign as the bulls want us all to believe.
