In today’s economic landscape, Wall Street seems to celebrate less-than-stellar economic data, leaving many baffled. The prevailing thought trend is that positive economic news translates to the Federal Reserve raising interest rates sooner than expected—something that typically dampens stock market enthusiasm due to increased borrowing costs. Consequently, unfavorable economic data that signals a potential recession also raises concern, as it could lead to declining corporate profits and slower growth, which would push stock prices down.
Interestingly, the optimal scenario for the market appears to be moderate economic growth, as it implies that corporate earnings can stabilize, while delaying the Fed’s rate hikes keeps investors hopeful.
This paradox, while perplexing, is a reality we must acknowledge, even if we find it hard to comprehend.
Six-Year Trend
The absurdity of this reasoning was evident last Friday. The Bureau of Labor Statistics reported the creation of 223,000 new jobs in April, sending Wall Street into a frenzy. The Dow Jones Industrial Average surged by 267 points, a remarkable 1.49 percent increase.
While this employment report was neither stellar nor disastrous, it did lead to a decline in the unemployment rate to 5.4 percent, along with a slight uptick in the labor force participation rate to 62.8 percent—still near its 37-year low.
The report also indicated sluggish wage growth, with workers earning approximately 2.2 percent more than a year ago. While any increase is positive, this level of wage growth largely fails to significantly improve the quality of life for most individuals.
Investors reveled in this news, believing they could enjoy the best of both worlds: moderate job growth coupled with a woeful first-quarter GDP growth rate of just 0.2 percent and a Consumer Price Index (CPI) below the Fed’s 2 percent target could postpone any interest rate hikes until next year.
Given a virtually zero federal funds rate and ongoing monetary easing in both Europe and Japan, why wouldn’t stock prices continue to rise? There are certainly several reasons one could propose against it, yet the six-year upward trend and Wall Street’s excitement suggest further gains.
Regardless of one’s market stance—bullish or bearish—it is warranted to take a moment for genuine reflection. The current state of the economy, alongside the market, appears illogical. Here’s some context for our present situation…
Bear Witness to the Madness
Shiller price-earnings ratio stands at 27.22, far above the historical median of around 16.
This ratio has only exceeded current levels on two notable occasions in the past 130 years: just before the market crash of 1929 and prior to the dot-com collapse in 2000. Consequently, there are two primary paths for today’s excessive ratio to adjust: either stock prices must decrease, or corporate earnings must increase.
Yet, there’s a possibility that stock prices could continue to ascend in the short run. For instance, in early 2000, the Shiller price-earnings ratio reached an astonishing 43.77—right before a significant market downturn. Who’s to say prices won’t soar even higher this time?
More critically, something fundamentally amiss exists within the global economy. Despite the Great Recession concluding in 2009, monetary policies remain in a crisis-like state. The Federal Reserve has added over $3.5 trillion to its balance sheet in the past six years, and although further easing is currently on hold, the federal funds rate hovers close to zero.
Meanwhile, Europe and Japan persist in their aggressive money-printing strategies to acquire financial assets. China is also considering introducing new monetary policies involving the purchase of bonds from local governments. “It will be a new monetary policy tool the world has never seen,” stated an insider connected to the Chinese central bank. “The format does not matter, and all possible means could be taken.”
Indeed, we find ourselves in the midst of the most extensive monetary experiment in the history of mankind. Let us bear witness to this unfolding madness—where the limits on stock prices seem nonexistent, and absurdities abound.
Sincerely,
MN Gordon
for Economic Prism
