America's misplaced market frenzy

As the US sharemarket soars to giddy heights, a closer look shows gains are based on pricing out a European disaster, rather than sustainable growth.

The US sharemarket appeared determined to demonstrate that it had the stamina to continue its recent phenomenal rally, with the Dow Jones Industrial pushing 0.4 per cent higher to reach its highest close since December 2007.

The Dow’s performance overnight tops off a first-quarter performance which saw it climb 8 per cent – adding a record 994.48 points – while the S&P500 put on a staggering 12 per cent.

But shares weren’t the only winners. The giant bond fund PIMCO also celebrated a highly successful first quarter, after an aggressive bet on mortgage bonds helped it outperform most of its rivals. Last year, PIMCO suffered its worst performance since 2006 after it slashed its holdings of US Treasury bonds just before the market embarked on a major rally.

But according to Gluskin Sheff chief economist David Rosenberg, there’s been an interesting pattern among the US sharemarket’s outperformers. Undoubtedly, the market darling was Apple, which soared 48 per cent and was responsible for nearly 20 per cent of the rise in the S&P 500. But if you look at the market more generally, the other stellar performers were low quality stocks that investors dumped last year, such as Bank of America (it bounced 72 per cent, after being the Dow’s worst performer last year). Sears Holdings also soared 108 per cent this year, even though the struggling retailer recently had to reassure investors about its liquidity and financial position after racking up a string of losses.

According to Rosenberg, this indicates "that this bull run was really more about pricing out a possible financial disaster coming out of Europe than anything that could really be described as positive on the global macroeconomic front.”

But not only did the first quarter see low-quality US shares outperforming their high-quality rivals, there was a similar pattern evident in global sharemarkets. Japan’s Nikkei index – which has caused investors so much grief over the years – rose by a ripping 19 per cent in the first three months of the year, while emerging markets were up 13 per cent. Even Greek shares climbed 7 per cent in the first quarter – as Rosenberg quips "that also tells you something about this rally. It’s called a dead cat bounce.”

But even though the US sharemarket is soaring to giddy heights, retail investors are continuing to withdraw funds. As Rosenberg notes, "what is still so fascinating is how the private client sector simply refuses to drink from the Fed liquidity spiked punch bowl, having been burnt by two central bank-induced bubbles separated less than a decade apart.

"Investors continue to use stock price appreciation as an opportunity to rebalance and diversify rather than chase performance – pulling $15.6 billion from US equity mutual funds so far this year while taxable bond funds have seen net inflows amounting to $59 billion.”

Instead, he argues, this rally is being driven by traders, in the wake of the European Central Bank’s move to flood European banks with more than €1 trillion in cheap money through its longer-term refinancing operation.

"It would then seem as though this is a market being driven by traders. Then again, it has been a very tradeable rally, just as the post-QE1 and post-QE2 jumps were. Ditto for the current post-LTRO rally. But liquidity is not an antidote for fundamentals. And a market that lacks breadth, participation and volume is not generally one you can rely on for sustained strength, notwithstanding the terrific first quarter that risky assets delivered. We lived through this exactly a year ago.”

Meanwhile, the market is ignoring some major danger signals – including real estate deflation in China, a spreading European recession, acute debt problems in Portugal and Spain and talk that Greece may need a third bailout. Rosenberg also points out that recent US economic data has been mixed, even though the country just experienced its fourth warmest winter since 1896, which should have provided a significant boost for employment, housing and spending.

And US consumers continue to be caught in a vicious income squeeze. As Rosenberg points out, even though personal spending rose by a faster-than-expected 0.8 per cent in February, personal income growth remains feeble. Income growth in February was a mere 0.2 per cent (half of what was expected), which was not even enough to cover the increase in the cost of living. Real disposable income dropped by 0.1 per cent, the third decrease in the past four months.

As Rosenberg points out, unless there’s some improvement in US incomes, there’s no way that the recent pick-up in spending can be sustained.


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