If one took the time to sit and listen carefully, the Bernanke press conference was an excellent opportunity to understand not only the decisions made but the economic philosophy underlying them. For that, Bernanke should be applauded. Transparency is almost always a good thing.
You don’t have to agree with the decisions made. However, knowing the thought process that leads to the decisions will help much more than whether his voice sounded shaky (which, if you listen to his testimony to Congress, it always does) or if he appeared to be sitting behind a piano (I actually love that comment. The imagery of Ben crooning a tune is priceless. Thanks, to Matt Phillips at WSJ).
In a manner similar to what St. Louis Fed President James Bullard discussed at the NYSSA luncheon I moderated last fall, Bernanke lays out the thinking behind the decisions. Therefore, here are a few observations:
• First quarter slowdown is transitory. Economic pace will pick up over time. Accordingly, the US economy should achieve a sustainable expansion. Continued improvement is expected. (Key words "over time". Lots of wiggle room.)
• Concern re inflation and its impact on jobs. Inflation (and any deviation away from stable, low inflation, which, of course includes deflation, for that matter) will inhibit job growth and must be guarded against.
• Related to this is the issue of long-term unemployment, which the Fed can virtually nothing about beyond seeking to help the current conditions and, thereby, help facilitate a virtuous circle of jobs creation. The long-term unemployment problem is one for the political process and other areas of the US economy.
• The Fed holds a “stock view”, which is actually Soros' "Reflexivity" – the feedback loop from the financial markets to the real economy and back and forth over and over. In this regard, QE (1 and 2) worked because “easing financial conditions leads to better economic conditions.” This is exactly the same philosophy and view expressed by St. Louis Fed President James Bullard at the New York Society of Security Analysts luncheon I moderated last fall.
• As for the potential of more QE, Mr. Bernanke took that off the table when he noted that in the Fed’s view the tradeoffs of more easing versus the risks of inflation and inflationary expectations are not favorable. (Perhaps for the reasons John Hussman has been fretting about.)
• Fiscal cuts (austerity) at the state and local level are not a major concern and, therefore, no plans to respond monetarily. The Fed is ready to react but no worries right now. (Not sure how this squares with the previous point.)
• The first step that signaled the end of monetary easing is occurring at the end of June, when QE2 ends. The second step that will signal the end of Fed easing is when the Fed stops reinvesting the US Treasuries and the mortgage back securities it has on its bloated balance sheet. This will, in effect, lower the size of its balance sheet.
• Rogoff and Reinhardt have shown that recoveries following financial crises tend to be slower and less robust. Bernanke believes this is true, as the problems tend to be in the credit markets and housing. He also, believes, however, that the reason for the post credit crises below average recoveries is that policy responses were not adequate. In his and the Fed’s board view, the aggressive and extraordinary actions undertaken by the Fed should help lead to a better economic outcome for the US. That said, he did acknowledge that the US economy growth (and employment, for that matter) thus far has been sub par but, as noted above, the Fed expects “recovery continues to be moderate but the pace will pick up over time.”
So what can we take away from this press conference that is of meaningful investment value? Two main items come to mind:
1 – The Fed is driven to maintain stability at the price level. They are very concerned about inflation (for the employment related reasons noted above). They are, however, deathly afraid of deflation. A Goldilocks approach to inflation is the only porridge that will do. And that is a very difficult thing to accomplish indefinitely.
2 – In the current environment and now that, in the Fed's view, the deflationary dragon has been slain, inflation and job creation are joined at the hip. Rising inflation will impact job creation and must be avoided at all costs.
Everything described above assumes an private sector led sustainable economic expansion lies ahead, which takes us to my third and most important point:
3 - No one asked the one question that I would have asked (and the one I have been asking for months now), What if the US economy does not achieve the escape velocity of a private sector led sustainable economic expansion?
What will the Fed do? What can the Fed do?
How will the markets, the economy (US and global), the geo and socio political environment react to another round of monetary easing? Why would QE 3, 4, or 5 work when 1 and 2 produced such transitory (and some would argue negative) effects?
If the Fed is right and a private sector led sustainable economic expansion does emerge, then the outlook will improve but to what extent remains to be seen. If not, then what?
Is there a plan B? A plan C?
Bottom line: What Bernanke did is a terrific thing. Transparency is almost always an excellent thing. Moreover, I truly believe he is sincere, knowledgeable, hard working, and has little in the way of political agenda (unlike Geithner). That said, being a good guy is not enough if the actions taken lead to a bad outcome.
Herbert Hoover was a good guy and look at how that turned out.
Friday, April 29, 2011
Friday, April 15, 2011
As most of you are well aware, yesterday the world of investing lost an exceptional investment professional, Joe Battipaglia. For me, I lost a friend.
It was in the late 1990s when I began producing and conducting market forecast events for NYSSA that I had the pleasure of first interacting with Joe. As a participant at my market forecast events and later as a guest on my podcast service ("Beyond the Sound BIte"), Joe was never dull nor without a forceful point of view. Matching his impressive physical presence, Joe's intellect always came with a provocative point of view, none more on display than the time he launched into his Libertarian perspective on the economy, the markets, and the financial services industry at my CFA Society of Orlando's Market Forecast dinner in early 2009. Unfiltered Joe was a sight to behold.
What I remember most about Joe, however, was his kindness and generosity. As David Gaffen at Thomson Reuters quoted me yesterday, "Besides the obvious physical attributes of looking like a linebacker, the best way to say it was that he was a very generous guy," said Vinny Catalano, chief investment strategist at Blue Marble Research.
"He truly was a gentle giant. He was a lot of fun to interact with both professionally and personally, and it's truly a large loss."
Perhaps my fondest memories of Joe was on the Forbes yacht a few years back (see the accompanying photos). As guests courtesy Wally Forbes and Vahan Janjigian and with Joe sporting a tan John Boehner would be proud of, we shared that warm early summer evening with drink and talk and friends.
He will be missed.
Posted by Vinny Catalano, CFA at 8:50 AM
Wednesday, April 13, 2011
Over the past several days, an awakening of sorts has occurred in Princeton, New Jersey, home of Nobel Laureate Paul Krugman. It is the reality that Barack Obama is no leader. This is a point that Mr. Krugman has begun to make several times of late, most recently in his blog today. This is point that I first made nearly one year ago.
So, as we await yet another speech from the man in the White House, here is what the Nobel Laureate had to say today (link to full commentary provided) and what little old me said one year ago. The rest is history in the making.
from Paul Krugman's blog today today:
"Various reports suggest that in today’s speech Obama will try to position himself as a pragmatist, as opposed to the ideologues of right and (probably) left. We’ll see how that works; as I recall, the last president we had who viewed himself primarily as a manager was … Jimmy Carter."
from this blog, June 9, 2010 (note the year):
The Real Problem with Obama
"Let me cut to the chase: It’s not about Mr. Obama’s capacity to show emotion beyond a clenched jaw that is missing. It’s about his capacity to lead. Just because someone has the title of leader doesn’t mean he/she is a leader.
In his media book tour for “The Promise”, author Jonathan Alter notes how impressed he was with Obama’s ability to manage the job – to synthesize the information and make an informed decision. This is no doubt due to his God given abilities. But it is also no doubt due to his educational training.
Mr. Obama is an excellently trained Harvard business manager. One of the attributes of a good manager is the ability to work for incremental improvements. Another is to be quite pragmatic. Mr. Obama has both qualities, so eloquently combined in Frank Rich’s commentary this past Sunday – incremental pragmatism. And therein lies the rub.
Being an excellent manager means espousing phrases like “don’t let the perfect be the enemy of the good”. Stop and think about that phrase for a moment, then ask yourself if that is something that a leader would ever articulate as the centerpiece of his philosophy?
Perhaps a Chicago trained politician might hold such a core view. Certainly a well trained manager would. But a leader?"
Will Mr. Obama surprise us today with a demonstration of spine and vision? Does a leopard change his spots?
Tuesday, April 12, 2011
If you have read any of my technical analysis work over the past years, you know that I am not a pattern recognition guy. However, there are times when one can't help but notice the emerging pattern involving long term interest rates. Specifically, the head and shoulders bottom that appears to be forming in the 10 year US Treasury (see accompanying charts).
When you add into the equation the following recent comment in an Economist article - "Since mid-November America’s Treasury has issued some $589 billion in extra long-term debt, of which the Fed has bought $514 billion." - it is hard not to conclude that once QE2 ends and the Fed stops buying long term Treasuries that a major demand factor will be removed from the mix.
The obvious equity market impact of rising rates is in valuation models, which will note that the cost of capital has just gone up thereby making equities less attractive. Could this explain why stocks have recently traded sideways?
Thursday, April 7, 2011
Something very peculiar is happening with equities.
For more than a year, stocks have not performed according to technical analysis Hoyle. Stock markets have risen on far below average volume. Correlations for virtually all economic sectors and many asset classes hover just below 1.00. And many technical analysis tools have been rendered impotent. Why is this so? Perhaps the answer lies in the nature of the beast: the structure of the market.
Over the past several decades, the structure of the market has changed. In the 1960s and 70s, traditional institutional investors (mutual funds, pensions, insurance companies, and large asset managers) replaced individual investors as the dominant traders of the day. Recently, hedge funds and now high frequency traders (with algorithmic traders in tow) have supplanted traditional institutional investors as the dominant volume drivers in equities. At the same time, products and services such as dark pools, derivatives, and structured products operate outside the traditional norms of equity investing.
Yet, most investors and many in the financial media operate as though there are virtually no effects, no consequences – intended and otherwise – that have occurred in this new environment. All is as it was. Or is it?
As for technical analysis, of all the tools that have worked with a reasonable degree of accuracy, perhaps none have been impacted more by the brave new financial innovation world than sentiment indicators.
Once the bastion of sound investment strategy, the human emotions of greed and fear afforded astute investors and traders with the opportunity to exploit the polar ends of investment human behavior. Ride the greed and fear train for as long as possible then, when things go too far, shift to other side (the contrarian side) of the equation. Not easy to do but highly rewarding if done correctly. However, given the changed world equities operate in today, the question has to be asked, Do such tools work in a world dominated by black box methodologies? A financial world without humans?
When it comes human emotions such as greed and fear, does a hedge fund manager, an algorithmic trader, or a high frequency trader base their decisions on judgment? Do they feel anything? Do they get swept up in the emotional tide of the times? Or is virtually every action taken done based on a set of rules and parameters that do not rely on such human qualities?
And that brings us back to the issue of technical analysis and, specifically, sentiment indicators. Do they still work? Has technical analysis lost a key tool in its toolbox?
Based on the evidence at hand, in the case of sentiment indicators, the answer has to be yes. In the case of volume indicators, the answer is also yes. In the case of momentum indicators, the answer is no.
The one market variable that is least impacted by our financial innovation brave new world is price. And price changes over time, which is what momentum indicators are all about, are tied to the real world of valuation, which is, in turn, tied to the real economy.
Is technical analysis dead? No. But I find it hard to argue for the status quo when so much has changed. Or Keynes once said, “When the facts change, I change my mind. What do you do, sir?”
Tuesday, April 5, 2011
“…it’s far from clear that the recovery will prove self-sustaining.”
NY Times, April 4, 2011
In his “The Transmission Mechanism for Quantitative Easing” commentary, Dr. Krugman delves into the how, why, and to what extent QE2 has worked thus far. He points to the sources of growth in US GDP (see accompanying chart) and highlights the fact that consumption and exports account for nearly 90% of the increase. Going a step further, Mr. Krugman then explores how a weaker US dollar and a higher stock market are likely significant factors to the results noting, “…casual observation suggests that a lot of the growth in consumer spending has been at the high end, which suggests in turn that a higher stock market might be driving it. And the lower dollar has clearly helped US exporters and import-competing firms.”
One conclusion from his analysis has to be the Fed’s intention of lifting the value of risky assets (stocks, specifically) and, thereby, triggering the “wealth effect” which then produces greater consumption which in turn helps the overall economy. However, as Mr. Krugman also notes, “…a lot of the growth in consumer spending has been at the high end…”, which helps bring him to a conclusion that is the crux of yesterday’s blog commentary: will the end of QE2 usher in an era of private sector led sustainable economic expansion?
If yes, then the US economy will (at best) continue to improve and maybe create the virtuous circle that enables the Fed and the government avoid, but more likely forestall, the day of economic reckoning.
If not, then what? Just a few points investors should contemplate as the stock market continues its Alfred E. Neuman (oh, excuse me, its climbing a wall of worry) rally.
Monday, April 4, 2011
I don’t know about you but I’m bored.
Stocks are locked into their upward drift waiting for what will almost certainly be an earnings season right around expectations (MERI data). And since we have 2 more months of monetary alcohol (that’s supposed to find its way into the real economy but is actually is stuck swirling around risk assets) to finally see if it has worked its magic and produce a private sector led sustainable economic expansion, the predictive dynamics of equity investing has been reduced to the investment equivalent of waiting for Godot. And therein lies the real rub for stocks.
The central issue for stocks is not whether earnings and guidance will exceed or (more likely) meet expectations. Nor is it a 15 multiple on a $90 S&P 500 operating number (which results in a 1400 target) that is at the top of the investment decision-making to do list. Rather, it is what happens after the monetary steroids have stopped being pumped into the sub par US economy? Which brings us to when things will start to get more lively – the third quarter of this year. For it is in 3Q11, when Chairman and head drink mixer Bernanke is set to stop (but not withdraw) the flow of monetary alcohol that we will see just what $4 to 6 trillion dollars has gotten us: a private sector led sustainable economic expansion or the early stages of the next economic crisis?
Until then, a plentiful supply of No-Doz is in order.