Economy and markets go down the rabbithole
The financial and economic landscape has come to look like something from Alice’s Wonderland.
American consumers now have less confidence in the economy than at any time since at least 1980, according to the latest monthly survey from Thomson Reuters and the University of Michigan.
You heard that right: People are more depressed than they were even at the depths of the 2008-2009 recession.
But just as in Wonderland, things aren’t necessarily what they seem. Confidence has been plummeting for three straight months, but that didn’t stop many consumers from spending in July. Overall U.S. retail sales rose 0.5% for the month, the biggest gain since March, the government reported Friday.
Watch what they do, not what they say?
The confidence and retail reports capped a week of extreme volatility in global markets, as investors struggled to understand just what they’re up against. Recession? Depression? Muddle through? An economic “soft patch” on the way to new strength?
The Depression crowd thought they had it right on Monday, when stocks worldwide plummeted in the worst sell-off since the 2008 financial-system meltdown.
But a day later the market clawed back two-thirds of Monday’s drop. It followed that on Wednesday with another plunge, then soared again on Thursday.
By Friday, with many investors and traders no doubt mentally exhausted, the Dow Jones industrial average managed to gain 125.71 points, or 1.1%, to close at 11,269.02. The Dow’s net loss for the week was a relatively modest 1.5%, after diving 9.8% in the previous two weeks.
Despite consumers’ grim mood, most of the hard evidence, including the July retail sales report, still says the U.S. economy isn’t collapsing. On Thursday the government’s latest report on new claims for unemployment benefits showed they fell last week for the fourth time in six weeks, to a four-month low.
Alice could relate to the difficulty of explaining this economy. “I can’t explain myself, I’m afraid, sir,” she told the hookah-smoking caterpillar. “Because I’m not myself, you see.”
For most Americans, this probably is the strangest economic and financial backdrop they’ve ever faced. And strange, in this case, translates into bewildering at best and terribly frightening at worst.
People with savings in the bank have been earning minuscule returns on their money for two years as the Federal Reserve has held its key short-term interest rate near zero. This week, after issuing a downbeat assessment of the economy’s near-term prospects, the Fed said it was likely to keep its rate at rock bottom for at least another two years.
The message to savers is, “You get nothing,” said Howard Simons, market strategist at Bianco Research in Chicago,
Actually, less than nothing. Subtract taxes on interest income and then adjust for inflation — which was up 3.6% in June from a year earlier — and money in the bank is losing value.
Yet cash has continued to pour into bank savings accounts. Americans have added another $320 billion to those accounts just since June 1, boosting the total to a record $5.86 trillion.
To have so much money content earning negative real returns runs counter to what we thought we knew about capitalism and economic rationality.
But after the deep 2008-2009 recession and stock market crash, many people believe they’re being perfectly rational choosing an insured bank account over the other alternatives for their nest egg.
And with stocks now in the red for 2011 — the Standard & Poor’s 500 index is down 6.3% year to date — that’s more justification for investors who’ve already given up on the market for good.
Companies, too, can’t seem to play it safe enough. Cash balances held by the S&P 500 companies reached $963 billion at the end of the first quarter, an all-time high, according to S&P. With their stocks down sharply over the last three weeks and economic uncertainty rising, what are the odds that corporate executives will want to boost spending and hiring as opposed to hoarding more dollars?
Yet the U.S. stock market still doesn’t seem to be buying the recession-or-worse story. The S&P 500 index now is down 13.6% from its 2011 high reached in late April. The average New York Stock Exchange stock is down 15.8% from its spring high. If investors really believed that recession was imminent you’d expect to see much more damage to stocks by now.
Corporate earnings continue to support share prices. Despite the struggling economy, operating earnings of the S&P 500 companies rose nearly 12% in the second quarter from a year earlier, according to Thomson Reuters. That could turn out to be the high water mark for earnings, but so far the stock market doesn’t see it that way.
Faced with earning nothing on cash or rolling the dice with equities, many investors are continuing to reject both for a third option: bonds.
U.S. Treasury bond yields tumbled this week despite Standard & Poor’s downgrade of the government’s credit rating to AA+ from AAA. Again, welcome to Wonderland: The government supposedly is a worse credit risk, yet investors elbow each other aside to buy more U.S. bonds.
The 10-year T-note yield ended the week at 2.26%, down from 2.56% a week earlier. The two-year T-note yield fell to 0.19% from 0.29%.
The new rush to Treasuries reflects heightened fears about the global economy and also was abetted by the Fed’s pledge to hold short-term rates down potentially through mid-2013. Some yield is better than no yield, or so bond buyers are figuring.
So eager were some investors to lock in rates this week that they were willing to buy so-called century bonds from USC that will be used to help pay for capital improvements at the university. The buyers will earn 5.25% a year until the bonds mature — 100 years from now.
But what are interest rates really supposed to be these days? The market has been badly distorted by the Fed’s unprecedented intervention: While the central bank is keeping short rates near zero it also continues to buy a limited amount of Treasury bonds with the proceeds of its $2.6-trillion securities portfolio.
And if the economy stumbles further, some analysts believe it’s only a matter of time before the Fed announces another massive bond-buying campaign, perhaps far larger than the $600-billion program it completed in June.
Bonds are far safer than stocks, of course. But with inflation at 3.6%, even 10-year Treasury note yields are negative after inflation. This isn’t a deal that investors ought to be happy with. Wall Street has a term for the bond market’s new reality: financial repression.
As Bianco’s Simons describes it, “You drive interest rates so low that you create an environment where the government can borrow at low rates and deprive its lenders of a real return.”
Down the rabbit hole we’ve gone.
