Despite a number of economic reports at the beginning of the month indicating continued problems, stocks rallied strongly on September 1st. The Nikkei was up over 1% and the major European markets were up between 1% and 2%. The U.S. markets were up over 2% in morning trade.
U.S. stock futures were up strongly in the pre-market and not even an incredibly weak ADP employment report indicating a loss of private sector jobs in August could derail the rally. In a rare moment of candor, even news service coverage found the rally odd. One article stated, "The sharp jump in U.S. stock futures is surprising given the domestic economic reports due out later in the morning. Often investors don't make big bets ... heading into key economic reports, particularly in recent weeks as data has consistently showed growth is slowing." And this was before the ADP report indicated that job losses in the U.S. are accelerating again after three challenging years and despite trillions of dollars of government stimulus spending.
What supposedly started the global stock rise was 'good' news on China's manufacturing index (PMI). The official government number was 51.7 in August versus 51.2 in July. While that may seem OK, albeit rather mediocre, the details indicate big trouble on the horizon. One component of the report was disproportionately responsible for the index not falling below 50 and indicating contraction. That component was the Input Price Index, which rose from 50.4 in July to 60.5 in August. Isn't that an inflation indicator? Doesn't that mean that input prices went up around 20% in only one month? Couldn't this possibly indicate that China is on the verge of experiencing major inflation and this is masking a big drop in manufacturing activity there? Then the U.S. PMI was released at 10:30AM and it unexpectedly rose. Of all its components, the highest number was Prices, also an inflation indicator.
In the U.S., the market was also pleased that home prices were rising. This news however was more laughable than ominous. According to Case-Shiller, U.S. houses prices in select cities were up 4.4% in the second quarter. The entire time period included the $8,000 home-buyer tax credit. According to other sources, an increase of $8,000 in the median average U.S. home price would be about 4.4%. So what happened was the government gave homebuyers $8,000 and they then spent an average of $8,000 more to buy the same home they would have without the tax credit. This obviously didn't make real estate any more affordable, all it did was create the illusion that this was the case. It wasn't just naive and gullible homebuyers that fell for this scam either. One prominent mainstream economist commented on the data, "Even with concerns about near term developments, we recognize that the housing market is in better shape than this time last year." Home sellers of course got an extra $8,000 courtesy of the U.S. taxpayer (if you check your bank account and notice $8,000 missing, this is where the money went).
So how is it possible that stocks are having a massive rally on the above news items? The state of the economy is not the short-term reason stocks rally or sell off. Stocks rally on liquidity. And it is obvious that central banks are injecting huge amounts of liquidity into the global financial system at the moment. The liquidity free lunch doesn't last for a long time however. It has to be paid for periodically with withdrawals of liquidity to prevent a huge inflation spike. This causes lots of volatility with stocks experiencing big price rises followed by sharp drops. We saw a lot of this in the second half of 2008 when the market went up and down like a yo-yo on crack cocaine. While this resulted in an eventual market collapse two-years ago, this is not likely to deter the Fed from continuing to play the same dangerous game again until the November 2nd election. Investors should brace themselves for a rocky market during the next two months.
Disclosure: No positions.
Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21
Daryl Montgomery is an independent contributor to ETFguide. His viewpoints do not necessarily reflect those of ETFguide or the ETF Profit Strategy Newsletter.
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