Let’s take a simple quiz and answer the following multiple choice question.
The stock market is hitting new highs because:
- Corporate earnings are at an all-time high.
- The economy is recovering.
- The market is being manipulated by the Federal Reserve Board.
- Investors lack common sense.
Corporate earnings are supposed to drive stock prices. That used to be true, before the market was made dysfunctional by Fed mingling, high-frequency trading, overbearing regulations and other factors. It’s not true anymore. At least not now. 
The stock market has been setting records, even though S&P company earnings declined 13% in the first quarter of 2015. That follows a 14% declined in the fourth quarter of 2014. Do you see a trend here?
As our friend Charlie Bilello of Pension Partners, LLC pointed out on Contra Corner, six out of the ten major S&P 500 sectors showed year-over-year declines, including consumer sectors, which were supposed to have benefited most from a decline in gas prices.
So if you answered “A,” go to the back of the class.
If you answered “B,” join your friends who answered “A,” as you’re both wrong. And if you answered “B,” you’re probably not a regular reader of this column, as we’ve pointed out that unemployment is much higher than it used to be, personal income is down, the housing market hasn’t recovered, economic growth has flatlined, government and consumer debt are out of control, and the world is coming to an end.
We don’t really think the world is coming to an end, but the economy is obviously not in the state of bliss that many media, politicians and pundits would have us believe. If the evidence above isn’t enough for you, consider the following from the Fed’s 2014 household survey:
- Nearly half of the respondents wouldn’t be able to cover an emergency $400 expense without selling something or borrowing money. When did the U.S. become a Third World country?
- About 31% of non-retirees have no retirement savings or pension, including one-quarter of people over the age of 45. About 28% of people who plan to retire said they plan to work to age 70 or later.
- Nearly a third of respondents had to forgo some medical treatment in the past year because they couldn’t afford it.
- About 81% of renters said that they would own their home if they could afford one, yet 50% can’t even afford a down payment and 31% said they couldn’t qualify for a mortgage.
- In spite of increases in housing prices, 14% of respondents with mortgages said they owe more than their home is worth.
Blame It on the Fed
So, to answer the question above, we’d go with C or D; maybe both. Defending our position, note that the Consumer Confidence Index rose in May (albeit, the rise was moderate and it was preceded by three months of decline).
As for the Fed’s role, Bilello wrote that, “Buyers and sellers have become fixated on one fact and one fact alone: easy monetary policy. While earnings and economic data have been weak in 2015, the Federal Reserve has responded by becoming increasingly dovish.
“Expectations for the long-awaited rate hike off 0% have been pushed all back to December, with Fed Fund futures now predicting there is only a 50% probability of that occurring. We are only a hair’s breadth away from expectations moving to 2016.”
So … no interest rate hike until 2016? Where did you first hear that prediction? Yours truly said as much in February. Of course, we’d rather be right than first.
Question 2 in our quiz:
When the Fed finally gets around to raising interest rates after nearly seven years of ZIRP (zero interest rate policy), the impact on the stock market will be:
- Negligible, as investors know it’s coming and it’s been factored into stock prices.
- Catastrophic, as low rates will no longer be propping up the market.
- Bearish, as the market adjusts to reality.
- Who knows? Investors should be expecting a rate increase, but with the market setting new records, they’re clearly looking short term.
We’ll go with “D” on this one, but we’d choose “C” if we didn’t have an opportunity to cop out. The asset bubble is likely to burst as some point and investors should be prepared for it.