Tomorrow is the big annual Fed conference in Wyoming. It typically draws the world’s most powerful central bankers. This is where, in 2012, Bernanke telegraphed a round three of its quantitative easing program.
The economy was still shaky following the escalating sovereign debt crisis in Europe, which had taken Spain and Italy to the brink of default. Draghi and the ECB stepped in first, in late July and made the big “whatever it takes” promise. This is where he threatened to crush the bond market speculators that had run yields up in the government bond markets of Spain and Italy to economic failure levels. He threatened to take the other side of that trade, to whatever extent necessary, in effort to save the future of the euro. It worked. He didn’t have to buy a single bond. The bond vigilantes fled. Yields ultimately fell sharply.
But just a month after Draghi’s threat, it was uncertain at best, that it would work. With that, and given the economies globally were still flailing, Bernanke hinted that more QE was coming at the August Jackson Hole conference.
The combination of those to intervention events ignited global stocks, led by U.S. stocks. The S&P 500 is up 55% from the date of Bernanke’s speech and the climb has been a 45 degree angle.
This time, this Jackson Hole, things are a bit more confusing, if that’s possible. The BOJ, ECB and BOE are QE’ing. The Fed has been going the other way. But in the past six months, they’ve backstepped big time.
The hawk talk went quite for a while earlier this year. Even Bernanke has written that the Fed has shot itself in the foot by publishing an optimistic trajectory and timeline for normalizing rate. It has resulted in an effect that has felt like a rate tightening, without them having to act. That’s the exact opposite of they want. They want to hike to restore some more traditional functioning of the financial system, but they don’t want to slow down economic activity. It doesn’t normally work that way, and it hasn’t worked that way.
So now we have Yellen speaking tomorrow, and people are looking for answers. We have some Fed members now wanting to dial back on public projections, as to not continue to negatively influence economic activity (Bernanke’s advice) and others getting in front of camera’s and telling us that a September hike might be in the cards.
But while everyone is looking to Yellen for clarity (don’t expect it), the show might be stolen by another central banker. Haruhiko Kuroda, head of the Bank of Japan, will be in Jackson Hole too. The agenda is not yet out so we don’t know if he’s speaking. But he could conjure up some Bernanke style QE3. Not a bad bet to be long USD/JPY and dollar-denominated Nikkei through the weekend (ETFs, DBJP or DXJ). Full disclosure: We’re long DBJP in our Billionaire’s Portfolio.
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As we head into the end of August, people continue to parse every word and move the Fed makes. Yellen gives a speech later this week at Jackson Hole (at an economic conference hosted by the Kansas City Fed), where her predecessor Bernanke once lit a fire under asset prices by telegraphing another round of QE.
Still, a quarter point hike (or not) from a level that remains near zero, shouldn’t be top on everyone’s mind. Keep in mind a huge chunk of the developed world’s sovereign bond market is in negative yield territory. And just two weeks ago Bernanke himself, intimated, not only should the Fed not raise rates soon, but could do everyone a favor — including the economy — by dialing down market expectations of such.
But the point we’ve been focused on is U.S. market and economic performance. Is the landscape favorable or unfavorable?
The narrative in the media (and for much of Wall Street) would have you think unfavorable. And given that largely pessimistic view of what lies ahead, expectations are low. When expectations are low (or skewed either direction) you get the opportunity to surprise. And positive surprises, with respect to the economy, can be a self-reinforcing events.
The reality is, we have a fundamental backdrop that provides fertile ground for good economic activity.
For perspective, let’s take a look at a few charts.
We have unemployment under 5%. Relative to history, it’s clearly in territory to fuel solid growth, but still far from a tight labor market.
What about the “real” unemployment rate all of the bears often refer to. When you add in “marginally attached” or discouraged job seekers and those working part-time for economic reasons (working part time but would like full time jobs) the rate is higher. But as you can see in the chart below that rate (the blue line) is returning to pre-crisis levels.
In the next chart, as we know, mortgage rates are at record lows – a 30 year fixed mortgage for about 3.5%.
Car loans are near record lows. This Fed chart shows near record lows. Take a look at your local credit union or car dealer and you’ll find used car loans going for 2%-3% and new car loans going for 0%-1%.
What about gas? In the chart below, you can see that gas is cheap relative to the past fifteen years, and after adjusted for inflation it’s near the cheapest levels ever.
Add to that, household balance sheets are in the best shape in a very long time. This chart goes back more than three decades and shows household debt service payments as a percent of disposable personal income.
As we’ve discussed before, the central banks have have pinned down interest rates that have warded off a deflationary spiral — and they’ve created the framework of incentives to hire, spend and invest. You can see a lot of that work reflected in the charts above.
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We talked last week about the employment data. It was broadly thought to be disappointing. Even though the headline unemployment rate dropped to 4.7%, the job creation number was weak.
So stocks fell sharply following Friday’s numbers. The dollar fell. And Treasuries rose (yields lower). All of this immediately priced in a gloomier outlook and a Fed that would hold off on a June rate hike.
But remember we discussed how market professionals are trained to hyper-focus on the jobs numbers, even though the jobs numbers are far less important than they are in “normal” times. And with that, we said “it’s probably a good idea to use those moves as opportunities to enter at better levels (i.e. buy stocks, buy the dollar, sell Treasuries).”
That’s played out fairly well today, at least for stocks (the dollar is mixed, yields are quiet). Stocks have recovered and surpassed the pre-employment data levels of Friday morning. Small cap stocks are now trading to the highest levels of the year.
Remember, in the past two weeks we’ve talked about the similarities in stocks to 2010. Through the first half of this year, we’ve had the macro clouds of China and an oil price bust that shook market and economic confidence. Back in 2010, it was Greece and a massive oil spill in the Gulf of Mexico. When the macro clouds lifted in 2010, the Russell 2000 went on a tear from down 7% to finish up 27% for the year. This time around, the Russell has already bounced back from down 17% to up 4%. And technically, it looks like stocks could just be breaking out.
You can see the long term trend dating back to 2009 is still intact following the correction earlier this year. And the trendline that describes the correction has now broken.
As for broader stocks (the S&P 500), the chart looks intriguing too.
Similarly, the trend off of the bottom in the S&P 500 is clear, and a breakout toward new highs looks like it is upon us. New highs in stocks would get a LOT of money off of the sidelines.
With all of the above said, Yellen had a chance to respond to the Friday jobs number today, through a prepared speech for the World Affairs Council of Philadelphia. She downplayed the Friday numbers, highlighted the passing of global risks from earlier in the year, but she did note the Brexit risk (the coming UK vote on leaving/staying in the EU).
With that, perhaps they will use the market sentiment adjustment from the jobs data to their advantage, to justify passing on a June hike in favor of July.
That would give them a chance to see the outcome of the UK vote, and perhaps give them a chance to hike into positive momentum created by another round of stimulus from the BOJ (a possibility next week). Waiting another month is a low risk move. But again, we think the UK leaving the EU can’t happen/won’t happen – maybe down the road, but not now. Despite the popular polling reports, the experts are assigning a low probability. Plus, there has already been clear political messaging attempting to influence the outcome, and we expect that will increase dramatically as the vote approaches (June 23).
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Intervention has been the common theme we’ve discussed for the better part of the past two months. And this week, that theme is heating up.
We’ve explained why oil at $30 has posed a threat to the global financial system and global economy. And we explained the parallels of the systemically threatening (current) oil price bust and the 2007-2008 housing bust. But we also noted the key differences, and why and how this “cheap oil” problem could be easily solved, unlike the housing bust.
