The Federal Reserve is expected to announce its plans for interest rates today. Supposedly, the stock market is on hold until the Fed speaks. But it is not even clear why stocks rallied 47 percent since March's S&P 500 low of 676, that the state of the economy has anything to do with it, and whether anything that the Fed says or does will make a difference.
In a TV interview last night, I said that stocks had been rising due to the actions of traders, not investors. There are two games that traders play that have been driving up stocks. One is so-called flash trading, where big institutions hide behind dark pools to anonymize their front-running of orders to major exchanges through super-powerful computers. The second is making bets on earnings outcomes and profiting from short-covering when those results turn out to be better than expected.
I also predicted that the Fed would keep rates where they are because the risks of deflation are still so high that despite putting $23.7 trillion in financial bailout obligations on the U.S.'s balance sheet, the need to raise rates appears far off. Those risks were highlighted in a productivity report that showed output per worker had risen 6.4 percent while unit labor costs fell 5.8 percent.
As unemployment climbs towards 10 percent -- a level it is expected to hit and stay above in 2010 -- this means that workers -- whose spending accounts for 70 percent of economic growth -- will be hard pressed to increase their spending. Moreover, with capacity utilization at 68 percent -- in a strong economy it would be at 82 percent -- the potential to cut more people to boost that utilization rate, remains high.
Sure there are signs that the number of monthly jobless is declining, but as long as we continue to allow speculators -- who account for 81 percent of oil trading -- to place bets on rising oil and a declining dollar there remains some potential for stagflation. Here, all those unemployed people would be forced to pay more for gasoline and other commodities so that Wall Street traders can buy their Maseratis.
So what does this mean for investing in stocks? After getting burned by the dot-com crash, the collapse in housing prices, and last year's 50 percent plunge in global stock prices, individuals are not inclined to buy stocks now -- even if they had any extra cash. Some stocks, like Bank of America (BAC) are up five-fold from their lows, but due to the tens of billions worth of toxic waste on their balance sheets it is still impossible to estimate their future profits or their net worth.
If you're going to look at investing in stocks, consider ones that have earnings growth like Strayer Education (STRA). It has done well in a down market and it was among the best Why? People return to school in a recession and Strayer is making money and it just raised its guidance. Whether the price is right or not I don't know but I think it would be worth looking at.
Meanwhile, the Fed will say that it is keeping rates low, adding liquidity as needed and that it believes the risk of inflation is low as long as the economy remains fragile. The Fed may also point out that it is poised to tighten if the economy starts growing -- but that could be years off.
Update. the Fed just announced that it would leave rates unchanged and that by the end of October it will end a program of injecting liquidity into the economy by buying treasury securities.