Bulls found fresh legs on Wednesday with support from the FOMC, despite the reluctance of Greece to "play ball" with its creditors, which has been depressing investor sentiment. Everyone seems to agree that the unresolved debt crisis in Europe is the main thing holding back global economic recovery and the snorting stock market bulls. To be sure, the situation in Europe is not good.
The worry is that Greece might be too far gone to save, and then others will fall in a domino effect. To comply with the European Banking Authority's stress tests, European banks must raise capital and deleverage their balance sheets, so they are unloading their government debt holdings—but this hinders credit and economic growth. It's a catch-22.
Nevertheless, the "risk-on" trade continues, as emerging markets, Nasdaq, small caps, and commodities are the leaders, while U.S. Treasury bonds are lagging. Among the 10 sector iShares, Basic Materials (IYM) and Technology (IYW) have been the leaders this week—with IYW getting a big boost from Apple Inc. (AAPL) after its incredible earnings report on Tuesday. Apparently, investors believe that the U.S., Asia, and emerging markets can weather whatever storm that emanates from Europe.
The release of the FOMC Policy Statement gave stocks and gold prices a boost, while knocking down the dollar. Although they projected somewhat slower GDP growth, they also indicated that the fed funds rate would like stay rock-bottom at least through 2014, and they left open the door for further policy action, assuming inflation remains low and unemployment high. "Don't fight the Fed" was the mantra that goosed the bulls.
However, economic growth will continue to be sluggish until the dollars that have been printed by the Fed actually makes it into the economy.
The M1 Money Multiplier (MULT) is the ratio of M1 to the St. Louis Adjusted Monetary Base. It essentially reflects the amount of money individuals and businesses have for consumption or investment relative to the money available for banks to lend. Since the bull market in equities and fixed income began in the early 1980s, MULT has steadily declined from around 3.0 to below 1.0 today (0.833 on 1/11/2012). But when the financial crisis hit in 2008, MULT fell hard even as the Fed expanded its balance sheet. It fell below 1.0 for good in July 2009. This means that there is no inflation in sight as each dollar injected into the banking system is producing only about 83 cents in economic value.
But with the latest Fed report showing $1.52 trillion in excess reserves versus only $94 billion in required reserves, there is a lot of liquidity in the system that can be deployed once banks feel the risks are manageable. Stock valuations and earnings yield are still quite reasonable, especially compared with the investment alternatives. So, any sign that Europe is getting its act together while U.S. economic reports improve should further improve investor confidence—bringing more of those reserves into the capital markets.
To this end, the Fed is trying to help support the ECB in keeping European banks liquid and sovereign debt manageable, and they are doing it through currency swaps. As of last week, the total had reached $103 billion in what are essentially loans to the ECB. Since the financial crisis of 2008, the Fed's balance sheet has jumped from about $850 billion to about $2.75 trillion due to quantitative easing, i.e., QE1 and QE2. Now we are seeing something of a mini-QE3 in the form of these currency swaps with Europe. Whereas most of the dollars printed for QE1 and QE2 remain in circulation, currency swaps with the ECB are expected to be unwound and removed from the Fed's balance sheet as credit conditions stabilize.
As for earnings reports in the U.S., what more can be said about Apple Inc. (AAPL)? This juggernaut blew away all analyst expectations with $13.87 per share in earnings on $46.3 billion in sales and 44.7% gross margin. They once again moved into a virtual tie with Exxon Mobil (XOM) for the largest market cap—at around $417 billion. Apple has now accumulated $97.6 billion in cash, and with cash continuing to pour into their coffers, they will likely institute a dividend or stock buyback program. If Apple starts paying a dividend of something around 2% or so, it would open up its stock to income investors to join forces with the growth-oriented investors that have driven the stock for so long. (AAPL has been rated Strong Buy in Sabrient's quantitative ratings algorithm.)
The SPDR S&P 500 Trust (SPY) closed Wednesday at 132.56. By the way, this popular ETF recently crossed over the $100 billion asset threshold—very impressive, and an indicator of the continuously growing popularity of exchange-traded funds.