The stock market rally, while liquidity driven by central bank intervention everywhere, has increased consumer sentiment at least in terms of polling. The interesting thing is that consumer sentiment isn’t showing up in the retail sales numbers judging by some of the recent retail reports from WalMart and others. However, today’s release of the University of Michigans Consumer Confidence showed an increase at the end of the month to 75.3 from the mid-month reading of 72.5. However, the end of January reading was 75. So, after a sharp decline in sentiment in the first half of the month the last half of the month got us back to about where we were last month. Combine all of this with the potential impact to consumers through rising oil and gas prices and you have to really work hard to put lipstick on this pig.
Thank The Fed
When Ben Bernanke announced QE 2 in 2010 (which ended just prior to the sell off last summer) he stated that supporting the financial markets would lend to consumer confidence which in turn would support the economy. He was correct. Take a look at the chart. Historically there is a fairly high correlation between the ebbs and flows of the stock market and consumer sentiment. As the artifical wealth effect is created by rising stock prices – consumers feel more confident about their current financial situation. The introductions of QE 1, QE 2 and, as was discussed yesterday by Michael Cembalest , the world wide liquidity convention between the ECB, BOJ, SNB, BOC and the Fed, have driven world-wide asset markets higher. In turn this has led to improved consumer sentiment. At least until the liquidity dries up and the financial markets contract once again.
There are two take aways from all of this. First, after $6 Trillion and counting of liquidity injections that have flooded into the financial markets, old pre-recession highs have not been reached. Secondly, after almost 3 years since the end of the last recession the consumer sentiment is still mired well into recessionary territory.
“What happens next?”
This the single most important question that investors should be asking themselves. When the markets began to rally – the media and market analysts began to extrapolate that advance well out into the future. The problem is that current economics and fundamentals don’t support that view. With profit growth slowing, input costs rising and a very tepid economic growth rate; the real potential of organic economic growth is very slim. Without the artificial stimulus of liquidity injections – it is highly likely that the economy would already be much closer to recessionary territory than not.
The markets, like a “heroin junkie”, are addicted to the rush of liquidity. Like a good “high” the liquidity push covers up past sins and leaves the markets feeling “bullet proof”. The problem is that each time the “high” has worn off the reality of the problems come surging back into light. Of course, as soon as the government “dealers” realize the symptoms and consequences of “withdrawal” they have been quick to supply another dose. The problem is that each dose is having less and less effect on the markets and the economy. How much further central banks can expand their balance sheet, how much more liquidity can be injected in the system and how many more toxic assets can be frosted over are questions that only time will answer.
However, what are the unintended consequences of debt, deficit and balance sheet expansions of this magnitude? There are many arguments both for and against the continuation of these expansions. The truth is no one knows sure. These are truly uncharted waters that we currently swim in. While on the surface the water is warm and the seas calm, at least momentarily, the problem is that none of us is really sure what lurks beneath.