There were a number of quite interesting developments in the market Wednesday, August 11th and I want to focus on those instead of my usual macro view.
The stock market sold off heavily yesterday presumably in response to the Fed’s recent statement, which admitted two things: (1) US economic growth is weaker than they previously thought (dollar negative) and (2) They were going to renew their efforts at monetizing US government paper (dollar negative).
Anybody following yesterday’s non-sensical markets knows what happened next: the dollar rallied. A lot.
Actually, the dollar initially sold off Tuesday afternoon right after the Fed announcement but quickly reversed and went up from there. Adding to the confusion, falling Treasury yields often provide a headwind to any potential dollar gains. Instead we saw the two-year Treasury hit a record low of 0.48% even as the dollar jumped like a penny stock.
Throughout all of this the Ten Year Note has consistently dropped in yield since the beginning of April.
Based on this chart it looks like the Ten Year yield is in a well-defined channel and is not at all confused about what's going on: deflationary weakness dead ahead.
Another telling bit of strangeness in the markets yesterday is that the price of gold did not fall nearly as far as I expected. For the past two months it has sported a very strong negative correlation with the USD index meaning that the +1.35 climb in the USD should have brought down the price of gold by or or more. Instead December gold jumped back up over the 00 mark right before the open of the US gold market, which is more or less where it finished the day, losing relatively little all things considered.
The Fed Statement
For an economy that is supposedly in recovery, investment professionals sure attached a lot of importance to seeing the Fed open up the Quantitative Easing (thin-air) checkbook one more time:
The day before the meeting:
"Markets have been increasingly pricing in additional quantitative easing measures as soon as today," said Jim Reid, strategist at Deutsche Bank. "The worst near-term development for markets is thus likely to be a meeting that suggests that no additional measures are currently needed. To sustain current levels, the Fed may need to at least signal that they are at least moving towards extending QE at a later meeting."
(Source - FT.com)
The day after the meeting:
"We’re in a worldwide soft patch and investors wonder why the Fed didn’t do more," said James Swanson, chief investment strategist at Boston-based MFS Investment Management, which oversees about 7 billion.
(Source - BusinessWeek)
The traders may have a point here. Given the obvious economic weakness, as exemplified by the expected downward revision of the 2Q GDP by nearly half to 1.3%, and given the fact that monetary policy (Quantitative Easing) has a rather well-known and leisurely time lag built into it, the Fed might have missed a chance to be proactive here. Now they either have to wait another 6 weeks for the next meeting, when things might be a tad sketchier, or they have to risk appearing panicky with a mid-meeting announcement of some sort.
Either way, I am both concerned and amused that we've arrived at a point in history where the "value" of entire multi-trillion dollar markets is dictated (rather dramatically too) by people's perceptions of how much thin-air money is going to be sent screaming across the fiber optic cables by Fed staffers’ operating keyboards.
Where we go from here
While the speculating world waits for the Fed to dump more liquidity into the markets, the rest of us are free to note that the real economy is not responding. Unfortunately, for legal and political reasons, the Fed is only willing to try 'unconventional' measures that follow the convention of shoveling new money and liquidity into the banking system, and specifically to the largest banks in the system.
The problem with this is that most job creation and recovery starts with small and medium sized businesses which are still not in a borrowing mood.
These businesses are both concerned about the future (as they should be) and reeling under a perverse mixture of government disincentives best measured in the thousands and thousands of pages of new rules passed by Congress this year with which they must comply. Additionally, and as if business during a downturn wasn't hard enough, the combined efforts of state and local governments to raise new fees to cover budget gaps have largely fallen on businesses. The combined costs associated with the new health care bill, increased Medicare and capital gains taxes, hikes in unemployment coverage rates, and higher state and city taxes have hiked the effective tax rate from 40% to 50%--a 25% gain for small and medium business.
In Manhattan, Robert Schwartz, the CEO of a three-unit shoe store chain, said he has never seen the tax burden this bad.
"This has been as hard as we've been hit in my 36 years of running this company," said Schwartz, owner of Eneslow Shoes, which employs 50 people, including part-timers, on annual revenues of under million. "It's a tough economy and our costs continue to rise."
Schwartz, who says he's putting his salary back into the business in response to the environment, adds that overhead from taxes and other outside charges have become unbearable. "I certainly don't think the new health care law will save me any money," he said. "Now New York City wants to develop this paid sick leave legislation that would give employees up to nine paid sick days. It's ludicrous. It takes the oxygen out of the blood."
(Source - NY Post)
The only people who are completely confused by the weak hiring picture have never owned a business and many of them apparently work in DC.
That's one end of the economic spectrum. On the other end we have DC so entrenched in a deficit spending mentality that this past week I read three articles describe looming budget 'cuts' at the Pentagon when what was actually proposed was a 1% increase. You know things have gone off the rails when an increase is described as a cut. The July fiscal deficit for DC, -$165 billion, was hailed for being '$15 billion smaller than last year' although $12 billion of that came from a reduction in spending, leaving an anemic $3 billion increase in revenues to point the way forward.
These data points indicate to me that our economy is going nowhere at present and will most likely be in full-blown retreat by the 4Q if not the 3Q. Congress will not be in a position to extend any new stimulus before the elections due to political wrangling (heck, they could barely renew the extended unemployment coverage) and the Fed seems stuck in a wait-and-see mode. Both stimulus and QE take time to work their magic. The prior efforts have worn out and are no longer contributing to our economic buoyancy.
My advice still mirrors that of Will Rogers of old: don't worry about return on capital, worry about return of capital. While I do not have a magic ball, I view the risks in the stock market as completely asymmetrical. Lots of potential downside compared to relatively little upside. If you can't afford to lose it, don't have your money in this market. It's eating dedicated professionals alive while going nowhere.
Unfortunately, my prognosis calls for more economic weakness, further house price declines, and future panicky efforts at stimulus and easing which will elevate the risk of a fiscal and then a currency crisis. Forewarned is forearmed. Be safe and be well from your faithful information scout.
