Deja Vu? Maybe, but with a Twist

"How come I love having an episode of deja vu? Its akin to an out-of-body experience, I would think.  It sits with me, happily, begging me to delve into my memory to find its match point." - Rachel Nichols

Is it just me but it certainly appears that we have seen this before.  Stocks flying higher on the back of supposedly good unemployment numbers and the expectation that the economy will rebound in the second half of the year.  Stock valuations are at their second highest level in history and yet they seem to continue higher.  The Federal Reserve wants us to think all is well with the economy so it continues to hint that higher interest rates are coming "soon" and that it will exit from its strategy of creating liquidity out of thin air, magically evaporating $4 trillion without any impact to the markets.

While on the surface things do appear to be headed in the right direction when compared to original expectations it is clear things are very different.  Every report that comes out either beats sharply lowered expectations or is revised lower once the real data is known.  Take for example first quarter GDP growth.  At the beginning of the year first quarter GDP growth was forecast to come in at 1.9% but this was relatively quickly revised down to 1.4%.  Subsequent to this the Bureau of Economic Analysis reduced its estimate to 0.2% but today's report on inventories showed an increase of only 0.1% instead of the estimated 0.6% so this will take the GDP data lower.  I would not be surprised to see GDP contract in the first quarter but this does not seem to bother the markets.

What does matter is low interest rates and on this front there is no end in sight.  Even with the newly printed unemployment numbers coming in at 5.4% the Federal Reserve will still not be required to raise rates any time soon as the anemic GDP growth shows a complete lack of economic traction which should keep inflation at bay.  Furthermore while the unemployment numbers are clearly heading in the right direction it appears that businesses have little desire to add more workers as production levels were stable as was the work week and earnings.  This leaves little doubt that the consumer will not be a catalyst for growth in the second half of the year, resulting in continued slow growth and no chance of an interest rate hike.  Furthermore the thought of raising interest rates blowing the budget deficit into orbit is not something that anyone can stomach particularly in this run up to the presidential elections so to me these rates (outside of an unknown catastrophic event) should remain mute.

In fact with rates in Europe below zero (you pay to have them hold your money) and debt across the globe continuing to spiral higher it seems that Deja Vu is back.  Therefore to me it is not whether the stock market will collapse it is just from what altitude.  Looking at the S&P which sits just below its all time high at 2116, there is no reason to believe that 2500 or 3500 is out of the question.  As long as interest rates stay low, which I believe that they will, the market seems content to rally higher, poor economic data or not.  The issue then is that if it is overvalued at 2116 and could correct to at least 1500 on the downside then if it does get to 3500 and corrects to 1500 the pain will be far greater.  This will be the same story of 2000 and 2008 repeating itself but there is a twist.

In the past the market buckled to local pressures which were normally related to higher interest rates slowing the economy too quickly.  The solution was to lower interest rates and free up liquidity.  This time around, with the world awash with debt and interest rates at unsustainably low levels, there is no safety valve.  This is what makes this time around Deja Vu with a Twist.  What concoctions can they come up with next time to "save" us from their mess?  I came up with the solution a few years ago which was laughed out of the room; but I will repeat it here and - the global bond.  In fact the more I see the madness the more I am sure that this will be the result.  If there is a global meltdown caused by global debt the only solution would be to sweep the balance sheets clean by rolling the whole lot into one massive global bond supported by the goodwill of all the countries of the globe.  Next to impossible I can hear you say, but what choice will they have and, if that ever happens, you will be able to say "Now that is Deja Vu with a Twist!"