Well, the waiting is over. Ben Bernanke spoke, announced no new quantitative easing, scolded the politicians and…the world didn’t end. How could that be? For the last two weeks, all I heard was that Bernanke’s speech at Jackson Hole was the most important thing on the agenda and that “the market” was expecting him to announce further monetary easing. If he didn’t meet or exceed those expectations, all manner of destruction would supposedly descend on Wall Street. As it turned out, the disasters last week were of the natural variety, one before the speech (earthquake) and one after (hurricane/tropical storm Irene). Unless Bernanke has gained powers that no Fed Chairman before has wielded, I don’t think we can blame him for either.
The market did initially fall after Bernanke’s speech but quickly turned around and ended the day higher. There are several potential explanations for that:
- Bernanke’s announcement that the September meeting had been extended to two days gave “the market” hope that more easing will come out of that meeting.
- “The market” wasn’t really expecting him to announce anything new.
- Investors believe the economy will be better off without more quantitative easing.
- His public scolding of the politicians on fiscal policy puts more pressure on the super commission to do something substantive.
- The earthquake caused a glitch in Wall Street’s computers that forced them all to buy in advance of the hurricane.
- No one knows why the market went up Friday.
Personally, I’m leaning toward 5, but the real answer is more likely 6. There were more buyers than sellers Friday. Neither I nor anyone else can possibly determine the motivations of all the buyers or sellers. All we can say for sure is that buyers as a group felt more urgency than sellers and pushed prices higher. There are times when there is a definite connection between an event and the market action but Friday was not one of those days. The fact is that most days, stocks are affected by so many different factors that determining “the” cause of the markets movement is impossible. “The market” is the sum total of millions (maybe billions or trillions) of individual decisions that affect prices. While general information can be gleaned from the pricing of the market, the day to day movements are no more predictable than a coin flip and about as informative.
What markets are telling us right now is that confidence in future economic growth is severely impaired. Low price to earnings ratios tell us that expectations for future corporate earnings are low. Gold near an all time high tells us that investors are more concerned with preserving existing wealth than creating new. It also tells us that investors fear further devaluation of the US dollar – and all other fiat currencies for that matter. Negative real interest rates tell us that investors expect future GDP growth and inflation to be low. High credit default swap prices and interbank lending rates tell us that the European banking system is under stress. The price of Greek bonds tell us they will likely default. One can also infer from the strength of the Euro versus the US dollar that the weaker members of the Eurozone will leave the Euro and that the remaining members are in a stronger position than the US. At least that’s what I think it means. Someone else could and probably does have a completely different explanation. That’s what makes a market. Here’s what the market doesn’t tell us or anyone else – whether these aggregate expectations will prove correct.
We can never know what the market will do in the future because we can’t know what economic policy will be in the future. There were surely some who were disappointed with Bernanke last week because they believe more quantitative easing would help the economy. At Alhambra, we were quite pleased that he refrained because we believe more quantitative easing would be just as negative for the economy as the last round. Like Bernanke – and I can’t believe I’m agreeing with him – we believe that “most of the economic policies that support robust economic growth in the long run are outside the province of the central bank.” We also agree with him that the US economy is slowly – very slowly – healing on its own and that the future of the US economy is still bright. Realizing that bright future is, however, dependent on getting our fiscal house in order.
The market right now, as detailed above, is priced for pessimism. Whether that proves correct depends on future policy and if Bernanke’s speech means the Fed is done with further easing, a step in the right direction has been taken. As Bernanke noted, commodity prices are falling – with the exception of gold and even that cracked a bit last week – and that is a positive for future corporate profits, hiring, investment and consumer spending. While economic growth expectations have played a role in reducing these prices, we believe a more important factor has been the stabilization of the US dollar in foreign exchange markets. That is a direct result of the end of QE 2 and now the lack of QE 3.
Fiscal policy is, as Bernanke noted, the more important factor for future growth at this point. On that front, I have learned to temper my expectations. The super commission that will start meeting soon has a difficult task before it and unfortunately, I do not believe they are up to it. The members of the committee are not known for their ability to compromise and with an election year looming, politics will play a large role. However, even without a major breakthrough from the committee, we do believe the US economy will steadily improve in coming months. Commercial and industrial loans have been rising since late last year and investment in equipment and software is rising. Personal consumption is still rising and private debt service ratios are falling. The weak link continues to be construction but as Bernanke noted last week, activity will eventually recover if for no other reason than population growth and household formation. We think we are near that point when construction could start adding materially to economic growth.
The US economy is not growing anywhere near its potential but Bernanke took a small step in the right direction last week. We now await President Obama’s speech on policy and the fiscal commission’s recommendations. While we don’t expect major improvements to policy from either of those avenues, maybe they too can take some baby steps. Any incremental improvement would be beneficial.
Last week’s economic reports were the same mixed bag we’ve come to expect this year. Housing related reports were grim, manufacturing a bright spot, employment mediocre at best and sentiment sour.
Both Goldman and Redbook reported slower sales in the previous week. Sales are still rising at a 3-3.5% rate year over year but momentum is slowing. That isn’t surprising given the deep pessimism apparent in the consumer sentiment surveys. It’s also a function of a jobs market that continues to disappoint. Jobless claims rose back over 400k last week to 417k. Part of that was due to the Verizon strike but it is very disappointing that claims can’t seem to get under 400k and keep falling. In addition, jobless benefits are running out for a lot of the long term unemployed and that will likely have an impact on disposable income.
The housing news continues to be grim. New home sales fell by 0.7% last month to 298k units. Median prices fell 6.3% but inventory remained steady at 6.6 months. Mortgage applications for purchase fell 5.7% and refinance applications fell as well despite record low interest rates.
The bright spot of the week was the durable goods report which showed an increase of 4%. The motor vehicle component was the star, up 11.5% as it appears the Japanese related snap back has arrived. Ex-transportation, orders were still up a solid 0.7%. The one drawback to the report is that it is from July and the regional surveys for August have shown weakness.
2nd quarter GDP was revised down to 1%. The year over year growth rate is 1.5% down from 2.2% in the first quarter. Momentum is obviously slowing. That showed up too in the corporate profits report that accompanied the GDP report with profits flat year over year. Whether this turns into a new recession is unknown – obviously – at this point but we continue to believe growth will pick up over the balance of the year, not least because of the fall in commodity prices.There is still plenty to worry about outside the US too though – Europe is at the top of the list – so that is subject to change.
US stocks rose strongly last week with the S&P up nearly 5%. Emerging markets were more mixed with some markets taking significant hits. Korea fell over 5%, Indonesia 6% and Thailand 7.6%. European markets were more mixed with a bias to the upside. Commodities were up a bit but are still in a downtrend that we think will continue as long as the dollar remains stable and growth prospects remain weak. REITs stabilized but are in our opinion, still overpriced.
Stocks appear to have stabilized for the time being. Sentiment is negative but not at extremes and insider buying has picked up significantly. Volatility is starting to come down and based on past experience, further near term upside should be expected. Developments in Europe and the emerging markets as well as ongoing economic developments in the US will determine whether it is anything more than a bounce in an oversold market. There is still a lot of uncertainty to deal with in coming months and any unexpected shock could easily push us right back into recession. We are more positive toward equities than we’ve been all year but will continue to invest cautiously until we have better visibility on the economy.