There was a marked deterioration of market fundamentals from late
2009 through July, 2010. The apparent negative impact on the
prospects for economic growth and for the stock market happened
very quickly and with a vengeance.
As I have discussed, the Fed shrunk its balance sheet and the monetary
base over the Feb.-Jul. 2010 period. Specifically, the monetary base
was cut by a large 7.3%. I do not think the Fed was being malevolent.
I believe they wanted to get a jump on their "exit strategy" in
anticipation of the development of private sector credit growth and the
eventual tapping of the $1 tril. + in excess reserves in the banking
system. Well, as you know, private sector credit demand, rather than
increasing vigorously, continued to wind down further, and this left
an economy and stock market exposed to a liquidity freeze.
By late April, my weekly cyclical pressure gauge, which includes
liquidity measures, started a tumble, paced by a sharp 13% decline in
my sensitive materials price composite. The reaction in the stock
market was immediate and sharply negative as it moved right along
with the decline of the weekly pressure gauge.
My SP 500 Market Tracker, based on rolling 12 months eps and an
inflation driven regression model for the market p/e, kept right on
rising and today stands at 1300 fair value for the "500." However,
the divergence between the earnings based Tracker and the weekly
pressure gauge was resolved by investors smack in favor of the
weakening pressure gauge on the premise that it was signaling that
earnings would eventually roll over.
The situation has improved somewhat since the end of July. The
monetary base is expanding again and even the broader measure
of credit driven liquidity has experienced some recovery as banks
bid for large deposits. The cycle pressure gauge has leveled off and
actually turned up sharply last week on a nice pop in sensitive
What is interesting here is that when system liquidity is squeezed or
frozen for an extended period , you get a recession and a bear
market in stocks. This liquidity squeeze / freeze lasted only five
months, but it produced significant negative results anyway.
Just how chastened the Fed is is anyone's guess, but it appears that
if the Fed wants to keep the recovery going, it will allow the
monetary base to expand moderately at least until cyclical private
credit demand recovers.
For now, it looks like stock players are going to watch Fed activity
re: liquidity, and weekly economic data like materials prices and
unemployment insurance claims carefully.
At 1105, the stock market is reasonably valued as you do not have
to have above normal earnings and dividend growth over the
longer term to earn decent returns. But we obviously have to see
a timely and favorable resolution of the frozen liquidity situation
to see a positive pay off. The Fed has made a healthy down
payment in recent weeks, and players will be looking for more.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!