Irrational Exhuberance

The stock markets started last week sharply lower lamenting the European morass. The Dow again dropped below 13000, NASDAQ broke 3000, and the S&P 500 crossed once more below its 50-day moving average. The zombie financials moved closer to their true value—zero—while even the manipulated and Buffett-pumped IBM succumbed a bit to reality. Monday afternoon, the Spanish 10-year bond rate again climbed above 6% while the Italian bond homed in on the same number. Trading volume was moderate.

Tuesday morning felt like the calm after the storm. The Spanish 10-year bond interest rates edged below the critical 6% level while the Italian bond edged closer to that mark. This is pretty typical as markets “held their breath” awaiting word from the FOMC Wednesday and Apple earnings due after the market close. On the IBM-stock-pumping front, IBM announced it’s raising its yearly dividend by 40 cents (0.2%) and adding another $7 billion for stock buy-backs. This helped to goose the stock market a bit. Indeed the Dow danced around the 13000 level most of the day ending at 13001. Speaking of everyone’s darling, IBM, it ended exactly at $200.00. We’re hearing terms like “priced to perfection” and perhaps “Humpty Dumpty” would also be appropriate for a stock with stagnant revenue and a book value of $18—half of which is “Goodwill.” After the close, Apple reported strong and revenue numbers—crushing previous-year numbers and beating estimates.

Wednesday was another “risk-on” day led by a nearly 9% gain in Apple and nearly 2% for IBM. Gold miners caught fire today rising 3% to 5% while zombie banks lagged. Gold itself though dropped. The S&P 500 and NASDAQ blew above their respective technical levels that they had just dropped below two days earlier. Of course, Wednesday was also the FOMC circus day with Bernanke giving a news conference. VXO (fear gauge) gapped down to close at 16.12. Spanish and Italian bonds both eased downward on their interest rates.

For context, here are some highlights from Bernanke’s press conference a year ago:

The end of the program [QE2 at the end of June] is unlikely to have significant effects on financial markets or on the economy….we subscribe generally to what we call here the stock view of the effects of securities purchases….Why not do more [stimulus]? … The trade-offs are getting less attractive at this point. Inflation has gotten higher. Inflation expectations are a bit higher. It’s not clear that we can get a substantial improvements in payrolls without some additional inflation risk and in my view if we’re going to have success in creating a long run sustainable recovery with lot’s of job growth we’ve got to keep inflation under control….If we fear that inflation expectations look like they’re becoming less anchored, we would have to respond to that….The United States has a very serious long-term fiscal problem…i think it’s the most important economic problem at least in the longer term that the United States faces. We currently have a fiscal deficit which is simply not sustainable over the longer term and if it’s not addressed it will have significant consequences for financial stability, for economic growth and for our standard of living.

Here we are a year later with Operation Twist expiring in June and high gas prices again, but the tone is much more accommodative than then (taken from the Federal ReserveĀ transcript):

And if appropriate and depending also on assessment of the costs and risks of additional policy actions, we are–remained entirely prepared to take additional balance sheet actions if necessary to achieve our objectives. So those tools remain very much on the table and we will not hesitate to use them should the economy require that additional support….Our intention is to maintain highly accommodative stance of policy for the foreseeable future and we remain able and willing to take further action if necessary….And we remain prepared to use balance sheet tools to support the recovery and to help make sure that unemployment continues its downward path towards longer-run normal levels.

Now, why don’t we do more? Well, first I would again reiterate that we are doing great deal, policy is extraordinarily accommodative, we—and I won’t go through the list again, but you would—you know all the things that we have done to try to provide support to the economy. I guess the question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased reduction—a slightly increased pace of reduction in the unemployment rate? The view of the Committee is that that would be very reckless.

And to be good voters and good citizens, they need to understand, you know, something about what the Fed does. And also, to communicate with markets so that markets can better appreciate, you know, what our monetary policy plans are in order so that interest rates and other asset prices can appropriately reflect those plans.

…the purpose of monetary policy is to achieve our objectives of maximum employment and price stability. It’s not to disappoint or not disappoint investors. So we will take actions based on those economic objectives and not try to achieve certain market outcomes.

Based on these statements, it’s understandable that the stock market celebrated a bit. Keep in mind though in spite of this jawboning, nothing substantive changed in the stated plans of the FOMC.

Stocks opened moderately lower Thursday as stocks again met resistance to rising further from current lofty levels. Spanish and Italian bonds resumed their climb in the morning but reversed by the close. The unemployment report was not at all positive with new unemployment claims about flat, but new jobs tumbled to 120,000 from a previous three month average of nearly 250,000. That didn’t matter. Stocks soared through the close for no particular reason unless this was an expression of the “bad news is good news” syndrome. IBM gained another 1%. VXO dropped below 16 on light/moderate volume. The bizarro world continues as U.S. Treasuries rose strongly also.

Friday stocks were poised to open flat or fall based on the Spanish bond downgrade by Standard and Poor’s. Despite the downgrade, the 10-Year Spanish Government Bond managed to close below the critical 6% level. Amazon.com captured the stage as it rose over 15% in one day! The funny thing is, this happened in light of Amazon’s playing games (legal though they were) with their quarterly accounting. See no evil, hear no evil, speak not evil. By contrast, one of the good guys and gold miner (on my watch list), AEM, gapped up with nearly a 10% gain on legitimate strong earnings.

The government-baked GDP numbers for the first quarter were down, lower than expected, and even more distressing when the components of it are scrutinized. After such favorable weather conditions last quarter, the prospects for the second quarter are even more bleak putting the U.S. is in very real danger of slipping into formal recession. In the face of this negative news, stocks plowed ever higher. Investor sentiment for the week moved bearish, but the fear index for Friday remained in about the same low range. Volume for the day was on the low end of moderate. For the week, the stock market indices rose over 1.5% presumably as a result of Bernanke’s comments.

Finally, here’s a pretty good article explaining the bias the Federal Reserve has to act in a manner that favors banks and insurance companies.