Liquidity Provides Temporary Hope

The lure of liquidity is all the talk along with the side effects of who wins and losses from the free money. Economic growth it the real question mark for investors longer term. The talk around stimulus is always market moving to start, but it is the sustainability that really matters. The last two attempts of quantitative easing didn’t work and the odds it does this time around are not high. It is all about the economy achieving sustainable growth and the numbers last week were anything but impressive. In fact there were more warning signs of stalling than growth.

Gasoline topped $4 per gallon for the month and that is the first time ever we have seen those levels this time of year. Where are the headlines about that? The dollar is getting weaker and that isn’t going to help the price of gasoline. The policies we have put in place in relationship to energy will continue to hurt the consumer as the increased cost of compliance are always passed along to the consumer.

Banks have already stated that increased costs of regulations now put the spread between Fed cost of funds and mortgage rates at 1.5% versus the 0.5% prior. Translated the rate of a thirty year mortgage is still near the 3.6% mark and likely will not fall much despite the focus of QE3.

Food and energy costs are rising again as seen in last weeks CPI data. This type of inflation is discounted as temporary, but the reality of it now to the consumer is real. Gasoline has risen a minimum of 50 cents a gallon at the pump. That translates into an extra $40-50 per month for the consumer. Food costs are up nearly 10% costing the average consumer another $30 plus per month. When you multiple that times millions of consumers it adds up to money taken out of discretionary spending.

Bernanke and friends made statements they wanted to create jobs and help the middle class. Increasing money supply isn’t going to get the job done. It acts as a short term catalyst, but it will take policy and regulatory changes to push the economy enough to create jobs and boost income for the middle class. Truth be known all the Fed money dump actually helps those the administration is complaining about… Wall Street.

I bring this up not to rain on the rally parade, but to keep in perspective this market rally. We are enjoying growth in stocks as a result of liquidity not economic growth. Thus, we can enjoy the returns the liquidity produces now, but it will not last with some sustainable economic policy. The dollar is falling and has erased all of the 2012 gains. The $1.33 level reached on the euro shows the erosion of the dollar. The dollar index has reached the March lows and falling. This is not good for the trade deficit, oil prices and other imported goods. This is a tax on imports, and again will be passed on to the consumer.

All of this adds up to taking what the market gives, but being very mindful that it is temporary. We outlined in the research update all the sectors to watch as we start the week. We have adjusted stops and the focus is on the ability to hold above the 1420 level on the S&P 500 index. Equally Europe has rallied without any real action taken relative to the financial issues facing the Euro zone. This is another warning flag of concern going forward.

The bottom line is nothing has changed, only the amount of liquidity in the system from the US Fed to produce a good will rally. Take what the markets give, but be ever mindful in the end it really is about the economy. Unless QE3 is far more successful than it’s predecessors, this is not going to be the answer to economic growth.