The Can Gets Kicked Again
Every investor knows that the U.S. has some serious economic problems. The government has way too much debt, the budget deficit is huge, economic growth is anemic, and it has been 30 years since the employment participation rate was as low it is now. Yet the stock market is on fire with the S&P 500 and Dow Jones Industrial Average closing in on all-time highs.
The rally in stocks is partly being fueled by the Federal Reserve, which is doing everything it can to provide liquidity and keep interest rates low. Perhaps that’s putting it too mildly. The truth is that the economy is drowning in liquidity, yet the Fed continues to buy up bonds as quickly as the Treasury can issue them. The Fed is also buying mortgage-backed securities. These actions, in addition to the the low fed funds rate, are keeping just about all interest rates low, which is exactly what the Fed wants. Low rates make safer investments undesirable. They force investors to consider riskier investments such as stocks. They also make current dividend yields extremely attractive.
The other factor driving stocks higher is Washington. Unfortunately, politicians have learned that they don’t actually have to do anything. In fact, they have learned that they can simply push off important decisions. They did it again today by raising the debt ceiling for another four months. Whenever politicians delay an important decision, investors breathe a sigh of relief and stocks move higher. The fiscal cliff, after all, turned out to be a joke. Nothing meaningful was resolved.
While it is true that some companies, such as IBM and Google, are announcing encouraging results, most companies are not really doing very well. Yes, they are beating expectations; but for the most part year-over-year revenue and earnings growth is not strong.
I can’t help but worry that such government actions (or inactions to be more exact) are setting us up for another sell-off. While I am not yet ready to take all my money off the table, I do believe it makes sense to use these rallies to pare back on certain positions.