Terry Sawchuk
Founder & Chairman
It is important to see both the positive and negative aspects of the economy and the stock market. In many ways, the market and the economy seem to be directly in line with each other and in other ways, not so much. Here is a list of positives for both the economy and the stock market.
- Unemployment is around 9%
- Retail sales increased for the 9th consecutive month
- Corporate profits have been solid
- Interest rates are still very low
- Inflation fears are probably overblown
Now, here is the list of negatives for both the economy and the stock market.
- Jobless claims unexpectedly ticked up this past week to 412,000
- European debt issues are back in the headlines
- Unrest in the Middle East
- Unknown nuclear issues in Japan
- Goldman Sachs is reported to be hot water over Mortgage Backed Securities
- QE 2 ends in June
Since the markets bottomed in March of 2009 we have seen almost a 100% rise in DJIA. It is a remarkable notion to think that the markets have nearly doubled since that time. The question that we ask, has the economy seen a 100% recovery? If you were to ask homeowners or any of the nation’s millions who remain unemployed I would think the obvious answer would be a resounding NO. If we would all agree that the economy does not seem to have recovered as much as the stock market we have to ask the next question: Why has the stock market recovered so much more than the economy? In our opinion, the answer is QE 2, the second round of quantitative easing.
What is QE 2 and how does it work? Here is an oversimplified answer. The Federal Reserve prints money. They take this newly printed money and buy US treasuries from banks and other institutions. Now that the banks have this extra cash they can lend it to small businesses and individuals. Banks do use some of this money for lending but they also have been buying equities and commodities. One would think that a bank is in business to keep cash safe for customers in saving and checking accounts and also to loan out funds. However, banks have been a little reluctant to make loans to anyone other than those who have fantastic credit. That list of people who have outstanding credit has been getting smaller and the banks have been looking at other ways to make money. The equity and commodity markets have been that place.
One of the outcomes of both QE 1 and QE 2 has been an inflow of cash into equities. This inflow has resulted in a higher stock market and in our opinion explains why the stock market has grown so much more since the bottom in March of 2009 as compared to the economy over that same period of time.
QE 2 ends in June of this year. It will not take long for the markets to start “betting” if there will be QE 3 or not. Ben Bernanke noted a week ago that economy is stronger and he does not expect the Fed to push for another round of quantitative easing. He went so far to say that the Fed might even end the program early. There is little doubt that economy has improved from the financial crisis of late 2008 and early 2009. The question is how much. Bill and I believe that QE 2 will probably end as scheduled but we also think that it is very possible that the Fed needs another round of quantitative easing as the economy is not strong enough to sustain itself without further assistance.
Based on this belief we feel that the markets could correct during the time when the Fed is not engaged in quantitative easing. In an unprecedented move to increase transparency, the Fed held a press conference shortly after their meeting. We will be watching closely to see what the Fed says and how they position themselves for the summer months and later this year. The Fed actions have recently had a direct impact on the markets.
Best regards,
Terry Sawchuk
Visit www.sawchukwealth.com to review past issues of The Market view.
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