One of the most quoted adages on the Street is “Don’t fight the Fed.” What all traders know is that Ben Bernanke has a powerful bazooka — even if it has a silencer on it.
Therefore it is easy to figure out why equity markets are up 3 to 4 percent this month with traders employing this strategy.
The Fed has been covertly injecting billions of greenbacks into troubled European markets recently through dollar-swap operations, providing needed liquidity for debt-laden euro countries. Bernanke has also spent trillions over the last few years buying US Treasuries to keep the 10-year bond yield pegged near 2 percent. It is highly debatable if these actions are good for the US economy, but it certainly affects market sentiment and emotion over the short term.
Dollar-denominated commodities like oil and corn will almost certainly move higher in price and suck more cash from Americans’ wallets in the next few months.
So when looking at the markets, it’s important to remember that in the short run, the market can favor economic weakness, like it does now — just so long as it’s not catastrophic or potentially systemic like Europe or the US in 2008-2009. So into this low return on investment environment the Fed is pushing investors into equities to find a decent return.
But that is not a strategy that has legs, the economic outlook being quite weak with unemployment remaining high and many Americans falling off the benefit rolls not into jobs, but other safety-net programs. Retail sales numbers, which were disappointing unless you ran a dollar discount store, do not instill confidence, and consumer credit is very allusive and almost prohibitive to attain.
While over the short run emotions and sentiment drive markets, economic fundamentals determine the long-term direction and returns.
So while the market is indeed off to a good start in January and perhaps a decent 2012 is in store, remember that with bonds and savings yields so low and home values depressed, a strong stock performance may just be an economic optical illusion portrayed by our illusory Federal Reserve.