Fed Does a 180

Does the most dramatic change in the Federal Reserve’s policy outlook indicate a change in the economy?

Prior to December 1, the Fed had widely broadcast that it intended to raise it benchmark rate 3 more times in 2019.   At the December meeting, they lowered that to 2 times in 2019.  In January after the horrid December stock market fall, the Fed changed once again, removing expectations of further rate increases.

The Fed has claimed to be data-dependent and the major economic data points have been indicating slowing growth for most of 2018, and more so since Q2 2018.   The Fed may have realized it overtightened, having raised the Wu-Xia Federal Funds Shadow Rate (Atlanta FRB) by more than 5%.  This was the fastest rate of increase in almost 40 years.

Now the Fed’s balance sheet normalization plan is being questioned and pundits are calling for an early cessation.   In November 2017 the median targeted estimate for the Fed’s balance sheet was just under $3 trillion.   The balance sheet peaked at $4.5 trillion and is currently a tick under $4T.  At the beginning of 2008 it was $800 billion.

So, from a target Fed Funds rate of 3% and Fed balance sheet of $2.75T, to a ‘normalized’ rate of 2.25% and a Fed balance sheet of $4 trillion.    The last few recessions we have seen the Fed raise rates right into economic weakness, only to cease then ease as the recession begins.   With that kind of track record its no wonder people believe the Fed to either be behind the ball, or the outright cause of recessions.

The irony is that the US may have crossed the Rubicon regarding diminishing returns from cheap credit (low rates) aka velocity of money.   While over the past 40 years we have lowered the cost of credit to induce consumption, each recession we must lower the rate below the previous recession lows.  And while we ramp up credit expansion to boost the economy (borrowing more and spending more today) each time, we are getting less and less growth for each dollar borrowed/spent (velocity continues to decrease).  And when there is low velocity, in order to create growth, exponentially larger amounts of money (credit) are required.

I have seen a few reports discussing the idea that low rates decrease future potential growth.  Essentially low rates fail to attract capital, reducing investment, reducing future productivity gains which reduces overall growth.

We have seen the Fed essentially stop tightening (balance sheet runoff should continue to at least this summer) the next step will be for the Fed to ease again, indicating a recession has begun.

Blame the Fed! (for following through on previously telegraphed guidance)

The Federal Reserve today reiterated it plans to continue what it has been doing and said it would continue to do, much to the chagrin of market participants.

While the last Fed minutes showed more dovishness, actual actions that are indeed ‘dovish’ have yet to occur.  Reducing expected rate increases from 3 to 2 in 2019 was widely interpreted as, ‘the Fed might stop raising rates’, for some reason.  History shows us that the Fed telegraphs well in advance what it intends to do.  Thanks to Alan Greenspan, this has been the case for more than 20 years now.

What has the Fed said it will do in 2019?  Raise rates two more times and continue to drain liquidity from the system via its bond roll-off program.  It is also expected that other nations’ central banks will also cease adding liquidity this year. China may not have gotten the memo though, as they just lower their Reserve Requirement Ratio by 1%, freeing up approximately $100 billion in bank liquidity.  This was announced on Friday, January 4, but was not even mentioned in the Saturday Wall Street Journal!

Here is a picture of global liquidity for 2019.  From adding more than any given year in 2017, to net withdrawal in 2019.   Adjust your expectations accordingly.

qt central bank 10 2018

 

Winter Solstice

They say its always darkest before the dawn, which seems appropriate as we meet the Winter Solstice today, at the lows of 2018.

There is a lot of commentary out there right now about hos investors are ‘worried’ about certain things like Brexit, slowing economies in China and Europe and if that slowing will seep into the U.S.  All these areas of concern have been with us for most of the year.  I have pointed out the Chinese credit impulse (slowing) more than a few times.  Housing and auto sales have been slowing for months.  The only difference is now there is a market decline and all these issues are being discussed.   If the market had not been declining these issues would still be with us, only accompanied by the tag line: “Investors shrug at concerns in Europe”.

In past posts I have described the coming year over year comparisons, 2018 v 2019, regarding earnings and GDP growth.  Every time I have mentioned that 2019 will look much worse than the stellar numbers put up in 2018, thanks largely in part to the one time cut in taxes.   That gave markets a boost and it was hoped that business investment, and wages would go up as a result.  Well it’s the end of 2018 and were still waiting.

The Federal Reserve gave a modest tip of the hat towards global economic concerns by reducing its estimate of rate increases in 2019 from 3 to 2.   There were even rumors that the Fed would skip raising its rate on December 19th and guide to 0 rate increases in 2019.   The Fed NEVER overtly bows to market or political pressures outside of an official recession or panic.   The Fed is in the process (as usual) of raising rates into the beginning of a recession.   Besides the yield curve, there are several other indicators that make recession in 2019 likely.  These indicators have been leaning this way for several months, and finally have tipped far enough that the markets are now concerned and discounting this likelihood.

As this is likely the beginning of a bear market (average -33% post WW2 era), we should expect large rapid moves, both down AND up in the markets.  During the bull market, a 2-4% pullback was common and quickly bought.  Today we see 2-4% intraday moves that continue to fall to hold support.  I expect several more percentage points south before a significant rally in stocks in the first few months of the year.   This will be an opportune time to reassess one’s risk tolerance and goals over the next 1-3 years, as well as make sure that one’s portfolio is properly diversified across asset classes. When stocks go down there are often other asset classes that are performing better, the core idea behind diversification.

It Doesnt Take a Weatherman….

Volatility Continues

2018 is sizing up to be a very volatile year.  Including today, there have been 11 2% down days this year.  There were 0 in 2017, 0 in 2006, and 11 in 2007.

The major indices are currently holding their lows from late October and Thanksgiving week, approximately 2625 on the SP500.  The interim highs were just over 2800, a 6% swing.

The big question of the quarter is if the highs or lows will break first.  Volume today is extremely heavy, so if the markets can close in the top half of todays range, that should bode well for the next few days.

Looking at the big picture, the 200- and 100- day moving averages are flat, the 50 day is sloping downward.  We see the longer term trend is flat while the short term trend is down.  The 50 day and 200 day are at the same level and the 100 day is near 2815.   The averages are clustered together near current prices while the markets intraday are given to large swings in both directions.

Concurrent news topics are the recent good news item of a 90- day trade war truce, and the bad news topics are the problems with Brexit, and the arrest of the vice-chairperson of Huawei, China’s largest cell phone maker.  She is a Party member, daughter of the founder who is also a Party member and has close ties to China’s military.  Maybe not the best person to arrest if one is trying to negotiate a Trade Truce.

My forecast from late 2017 was for large swings in market prices and we have certainly seen this play out.  When compared to past market tops, 2001 and 2007, one can plainly see plus and minus 10% moves as the market tops out then finally breaks down.  Its my opinion that a bear market has likely started, and we have a few opportunities to sell at “high” prices, and get positioned for 2019.

Fundamentally while employment and earnings are good, these are backwards looking indicators.  These are the results of a good economy, not indicators it will persist.  Housing and autos are slowing; defensive stocks are outperforming growth stocks, and forecasts for 2019 earnings range from 0% to 8%, a far cry from 2018’s +20% earnings growth rate.

So, what to do?  Is it more difficult to ‘sell high’ or ‘buy low’?   One is fraught with fears of missing out, the other fears of further declines.   Selling into market strength and perceived ‘resolutions’ to our economic headwinds might be the best bet.  Especially considering the chart below, where in 2019 the global Central Banks will be withdrawing liquidity until further notice, while the Fed insists on raising rates further.

cb balance sheets QT

Keeping Pace with Inflation

Inflation has been called the silent killer of wealth. It’s rarely discussed and many dollar picretirement income strategies ignore it completely. But over time, the steady increase in the cost of living can have a profound negative effect on your standard of living in retirement.

How inflation destroys wealth

As this chart shows, even at a modest rate of inflation, your spending power could decline by nearly 40% over the next 20 years.inflationNo one knows what the future may hold for inflation, but we do know that the Federal Reserve aims to keep the rate between 1% and 3% per year, and it has reached double digits in the 1950s, 1970s and 1980s.

Happy Thanksgiving !

Please note our office will be closed on Thursday, November 22 and Friday, November 23, 2018 in observance of the Thanksgiving holiday.  Normal operating hours will resume on Monday, November 26, 2018.

Feel free to contact me should you have any questions or if you have specific needs that require special attention.  You can reach me at 239-287-3789 or via email at pmcintyre@namcoa.com.

Have a safe and happy holiday!

 

Market Volatility–October

I believe we’re seeing a large repricing of growth expectations. The one time tax reform boost will wear off into next year, and higher borrowing costs, fuel costs are reducing discretionary income. 

In addition there is a great deal of leverage in the markets which will exacerbate declines. 

Often, at the end of bull markets/beginning of bear markets we will see relatively large price movements, 6-12%, down and up. I believe this correction has a good chance of bottoming or at least slowing in the immediate term, and  it’s bounce back could be half the decline, maybe more, which will be several percentage points. 

 

Focusing on keeping portfolio declines to the single digits while raising cash to be able to redeploy later can aid longer term returns–one has to have cash in order to buy low!   There is a very large amount of ‘bond shorts’ in the market which could set up a large ‘short squeeze’. Bonds were positive today. This is reminiscent of other recent periods when many bond speculators saw bond prices move very rapidly against them (UP) as they rushed to cover their deteriorating short positions.

 

Inflation scare is not the culprit here as inflation rates are slowing in several areas.  Something recent is that with the Fed raising interest rates, the yield, on 1-year and longer bonds is greater than inflation,  a positive “real rate” which is new to this economic cycle and takes a lot away from the ‘bonds dont pay so buy stocks’ argument.  The Fed further reiterated that it currently plans to continue to raise rates through 2019–even though we have already raised rates MORE than in past rate-raising eras.  I will have a chart of this in my Observations and Outlook this weekend.

Please reach out to me with any comments or questions.

 

Adam Waszkowski, CFA