Fed’s Still Printing: Markets May Be Celebrating, but Here’s Why I’m Worried

By Sasha Cekerevac.

It had been a long time since the Federal Reserve really surprised the markets. That is, before last week’s announcement that the central bank was going to keep its foot on the gas pedal—with the “pedal to the metal,” as the saying goes—leaving monetary stimulus in place.

As you probably know, at the last Federal Open Market Committee (FOMC) meeting, the Federal Reserve announced it would continue buying mortgage-backed securities worth $85.0 billion each month for the foreseeable future. Everyone was expecting some reduction in monetary stimulus; to have no change at all was quite a surprise.

But while the markets celebrated the news with new record highs, the fact that the Federal Reserve feels the need to continue pumping monetary stimulus into the economy actually worries me. Even with the stock markets near their highs, the bank’s interpretation of the current economic situation is certainly not as optimistic as many would’ve believed.

We have seen some data over the past couple months that indicate the pace of job hiring in the U.S. economy is starting to decelerate. At this point, the trend should have been for jobs growth to begin exceeding 200,000 per month. But while the level of job creation is still positive, it’s nowhere near the 200,000 mark, which is a concern.

The Federal Reserve is also worried about the continued drop in the participation rate. A person leaving the workforce is not a sign of economic strength. This is one reason that the Federal Reserve is continuing the monetary stimulus program, to continue enticing companies to expand and hire.

The problem, as I’ve stated in these pages many times before, is the fiscal side and not the monetary stimulus part of the equation. The fiscal part of an economy is the federal government, and what we are now witnessing with the budget debate is that politicians in Washington are willing to play games with the economy and people’s livelihoods.

With a host of new rules and regulations that could come down the pipeline, such as the new healthcare legislation, and the uncertainty regarding yet another sequestration with the ongoing budget debate, the effect—a leaderless federal government—means increased uncertainty for businesses nationwide.

Over the last couple of years, while monetary stimulus has helped certain sectors that are interest rate-sensitive, such as housing and vehicle sales, it is not a policy that can work everywhere. The Federal Reserve is extremely limited in its capabilities to help the economy. When it comes to taxes, regulations, and structural reforms, these are all part of the federal government.

What should an investor do at this point?

The real worry for me is that this inaction by the Federal Reserve to at least begin reducing monetary stimulus, even marginally, is a sign that the underlying economy is weaker than many people believe. The problem is that the Federal Reserve is running out of options for what it can reasonably do in terms of creating additional monetary stimulus.

Essentially, if this is it for monetary stimulus, and the Federal Reserve has few options left, then we have to look at the fact that revenues are not growing and earnings growth is going to be difficult. At some point, revenues need to grow, as much of the earnings growth has been on the back of cost-cutting and share buybacks.

I think the equity market is close to fully valued if we don’t get any revenue growth from corporations. Only so much multiple expansion is possible. If the Federal Reserve begins to reduce monetary stimulus and revenues are not accelerating, that’s a bad combination for stocks. If, on the other hand, revenues begin to accelerate, then the stock market can continue moving upward. But until we see this broad acceleration in revenues, I would certainly be cautious and take some profits off the table.

This article Fed’s Still Printing: Markets May Be Celebrating, but Here’s Why I’m Worried was originally published at Investment Contrarians