Why the Rally in Stocks Can’t Continue for Much Longer

Businessman analyzing investment charts at his workplace
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Friday’s trading session in the US contained something for everyone. A strong jobs report sent US stock AND bonds to record highs, while gold finished higher too, after initially selling off sharply.

What’s going on?

The headline jobs number saw non-farm payroll employment growth of 287,000 for the month of June, well above expectations of around 165,000. However, this followed a very weak reading for May, where revised jobs growth came in at just 11,000.

So, averaging the jobs growth out over the past two volatile months reveals a labour market that is slowing…or at least one that’s weak enough to leave the US Federal Reserve in no rush to raise interest rates.

That’s why stocks soared. The S&P 500 closed at an all-time high on Friday, at 2,129.90 points. That’s still a few points below the 20 May 2015 intra-day high of 2134 points, but it’s a record high for the close, nonetheless.

Not to be outdone, the yield on the 10-year US Treasury bond also closed at an all-time low on Friday. The benchmark bond yield is now just 1.366%.

Gold plunged around US$25 an ounce on the release of the report, but bounced back almost immediately as traders realised the Fed would remain on hold anyway.

What will it take to get the Fed serious about another interest rate rise? It seems no one really knows the answer to that. Or if they do, they don’t see the US economy being strong enough to warrant one for a long time. The only thing to do then is buy stocks…and bonds…and gold…and just about anything else that isn’t cash.

While the new all-time high is a positive for US stocks, the fundamental reasons behind it are dubious. For that reason, I remain a little sceptical. Things could go either way at this point.

That is, we could still be in a major topping out process, whereby the index makes marginal new highs before rolling over and selling off sharply. Or, it could follow Friday’s positive price action by continuing to break higher, giving this long running bull market another boost.

Personally, I struggle to see how stocks can continue to rally in the face of a slow-growth global economy, rising tensions just about everywhere, a fracturing Europe, and lofty valuations.

But what I think doesn’t matter. The only thing I know for sure is that I don’t know how all this will play out. Maybe we’re at the start of Ludwig von Mises’ famed ‘crack-up boom’, where asset prices everywhere rise as investors play pass the parcel with increasingly worthless cash and currency.

Knowing that you don’t know, and being ready to deal with any situation the market throws at you, is the best strategy you can have. Holding onto biases and ingrained (but potentially false) beliefs is the quickest way to go crazy and broke at the same time.

Because with over US$10 trillion of assets on a negative yield, and with covert currency devaluations the name of the game, having a static strategy of ‘this is what I think will/should happen’ is a recipe for disaster.

The truth is that absolutely no one knows how this grand and unprecedented economic experiment will play out. We’ve got a cabal of modern day John Law’s playing with printing presses across the globe. They’re confounded by the lack of inflation their games are producing…despite evidence of asset price inflation being all around them.

Like John Law, they’ll eventually be run out of their countries by an angry citizenry. Maybe not at risk of death, but the death of their reputations and policies will be just as bad to these egotists.

We’re not close to that point yet. But it’s coming, slowly but surely.

In the meantime, we can sit back and pretend rising stocks mean we’re all getting richer. Friday’s action in the US means Aussie stocks will have a good day today. We can pretend a little longer…

But Paul Kelly, writing in the Weekend Australian, is slowly beginning to wake up to reality:

Australia acts like a classic spoilt child. It has enjoyed the good life for so long, it refuses to believe its special privileges are being cancelled and that old disciplines need to be reimposed. When the Prime Minister and Treasurer tell the country we need to “live within our means” they are accused of being out of touch. In fact, the country is in denial; the longer the denial lasts the more ugly and painful the eventual economic crunch.

Kelly is right; we are in denial. Any attempts to rein in the deficits are sabotaged by special interest groups, determined to let someone else pay for their privileges.

That the Coalition is back in government is some sort of consolation on this front. If Labor had got in, the AAA credit rating that S&P warned about last week would’ve disappeared much quicker.

But the reality is that is it very difficult to reform spending when so many special interest groups don’t want reform to affect them. Australia is beset with lobby group parasites, all trying to get something for nothing. In many ways, they own the politicians.

And so democracy in Australia has descended into this. But has it ever been any different. The great stoic philosopher, Seneca, wrote about the malaise of public life in his day, way back in the first century!

Reminiscing about the ‘Golden Age’ of rule, he wrote:

To govern was to serve, not to rule. No one used to try out the extent of his power over those to whom he owed that power in the first place. And no one had either reason or inclination to perpetrate injustice, since people governing well were equally as well obeyed, and a king could issue no greater threat to disobedient subjects than that of his own abdication.

So try not to be too disheartened about the current state of affairs. It’s been going on for thousands of years.

Seneca himself lost his life due to politics. An adviser to the infamous Emperor Nero, his influence waned as Nero’s paranoia grew. Nero came to see Seneca as a threat to his power, and forced him to commit suicide.

These days, threats to power are cast aside with a lifelong pension. Maybe we have evolved, after all.

Cheers,

Greg Canavan,
For The Daily Reckoning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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