5 Reasons Why Stock Market Rally May Fizzle
NEW YORK (TheStreet) -- The stock market is surging and relieved investors are cheering on the news that a group of central banks is trying to stabilize the world economy and save European banks from going belly-up. But this party may not be able to last.
The Federal Reserve, the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank today announced a joint plan to enhance their ability to provide liquidity to the global financial system. They agreed to lower the pricing on existing temporary U.S. dollar liquidity swap agreements by 50 basis points from Dec. 5 until early 2013. That will, in short, enable banks to exchange dollars more easily.
The coordinated effort came after the People's Bank of China cut the amount the country's banks are required to hold in reserve overnight to help stem an economic slowdown. China eased monetary policy for the first time in three years by reducing the required reserve ratio by 50 basis points.
The next big central bank event will be the ECB next week. Investors are calling for ramped-up Securities Market Program (SMP) activity, but the European Central Bank could potentially employ other tools to address the crisis in Europe, leading to uncertainty toward which path policymakers will take.
The pop in the stock market today may fizzle, as the world economy has many catalysts that could lead to a reversion. After all, U.S. benchmark stock indices are now little changed this year amid record volatility. Below is a list of reasons the stock market rally may peter out today or in the days ahead.
1. The ECB Cannot Bail Out Europe. First and foremost, it's against the rules. The central bank can only add liquidity by purchasing sovereign debt in the secondary market and not directly from sovereign countries. The ECB has been doing this through the SMP program, but, acting alone, it cannot save the entire eurozone.
2. China Is Less Able to Buoy the World Economy. The second-largest economy in the world has been the engine for global growth as other developed countries have had slowdowns. Concerns over growth in the region are now front and center. The actions taken by the People's Bank of China today signal a heightened concern. Last week, the flash PMI (purchasing managers index) showed the economy moving into contraction, and the final PMI numbers will be revealed Thursday.
3. Corporate Profit Margins May Have Peaked. According to Moody's Analytics, U.S. companies are the most profitable they have been in 40 years. Some analysts say new technology and reduced labor costs over the past few years have boosted earnings, and that's why profit margins may narrow next year.
4. U.S. Unemployment is Unsustainably High. While the unemployment rate has fallen from a peak in October 2009, 9% is the highest seen since the 1980s (excluding the most recent recession). The details inside the latest report show that almost 6 million people have been out of work for six months or longer. The economy needs to start adding at least 125,000 jobs a month just to keep the unemployment rate steady, which is a tall order.
5. U.S. Politics. The lubricants for a smooth economy, the bank lending system and politics, are broken in America. The failure of the Super Committee to agree on a simple deficit-reduction plan last week shows the severity of partisanship in the U.S. It's feared that the country will struggle to drive growth with a lame duck government holding corporations and stocks hostage until the 2012 elections in a year.
That said, in the past few days we have received positive economic data out of the U.S. Yesterday, consumer confidence came in well ahead of expectations and, today, Chicago PMI, pending home sales and ADP's employment report likewise did the same.
--Written by Lindsey Bell in New York.
