I’d like to comment on two things that have been a huge disservice to the average (nonprofessional) investor. One is CNBC and the second is the Federal Reserve.
Do yourself a favor and don’t watch CNBC. Like all media companies, CNBC is in the business of collecting eyeballs. They want strong ratings so they can charge a premium for advertisements on their channel and website. In order to do this, they try to make everything they report seem really important when it really isn’t. When was the last time you saw them report something without the giant flashing red words BREAKING NEWS!!? They’ve pretty much tailored their content for day trading, because it’s fun and exciting, with the irony being that no day trader would ever watch CNBC for actual breaking news since it’s old news by the time they report it. So for long-term investors, CNBC offers little to no value outside of entertainment. These days, I primarily use the internet, Twitter and a few subscription services for financial news.
Not only do I think the Fed is also a disservice but has been a major contributor to the pain experienced by Main Street the past 15 years (exacerbating multiple boom-bust asset cycles while keeping Main Street in the dark). The general public was blindsided in 2008 and I fear it’s about to happen again so I guess you can consider this a public service announcement.
One quick point before elaborating on the Fed: I’m not making market predictions with this post but I do think it’s very important for any followers of this blog that are not clients of mine (meaning I don’t manage your investments) to take a look at your asset allocation within your portfolio and make sure it’s properly aligned with your risk tolerance. You should not have any money in the stock market that you might need to use in the next couple of years. That’s a general rule of financial planning but I think it’s important to stress this right now.
The Fed… I don’t envy the responsibility that Central Banker’s shoulder in today’s world. They have an extremely difficult job that one could say is nearly impossible to succeed at. Janet Yellen, the head of the US Federal Reserve, has an especially difficult job because she has inherited a disaster of a global situation from Ben Bernanke. Let’s outline the issue:
At this point in the game, the Fed’s most effective policy tool is confidence. This is why they put such a large emphasis on forward guidance the past few years. The marginal effectiveness of direct intervention, like a Quantitative Easing, has basically run out leaving the Fed only with their words. QE has done little to nothing to help the real economy. It’s done a whole lot for asset price inflation (i.e. stocks going up). Their job is to project confidence which is why they’ve been saying the past few years that the recovery is right around the corner and about to accelerate (even though it hasn’t yet, 6 years after the last recession ended). Their hope is that if people believe the economy is improving they’ll start to spend more, invest more, and so on, which will create a self-fulfilling prophecy. The issue I have with this is that the Fed is not honest with the public. But if I’m being honest, they can’t be – hence the unenviable position. This has to do with the design of our financial system. It’s a credit based system backed solely by faith, with massive amounts of leverage that requires ever-expanding credit or else it spirals downwards upon itself (a deflationary spiral). If the Fed actually said “Uh oh, the global economy is slowing pretty quickly, everyone better prepare for tougher times ahead” the velocity of money would fall precipitously and the Fed would create a negative self-fulfilling prophecy. So they simply pretend that everything is rosy and always improving, all the while hoping Average Joe doesn’t actually pay attention to the economic data and continues to spend his money. Then CNBC takes what the Fed says as gospel and parades their omnipotence which only makes it even worse for Average Joe. The biggest risk that I see today is the investment market’s losing faith in the Fed’s “ability” to “manage” financial risks.
But the simple truth is that everything is cyclical. The economy heats up, then slows down. The stock market goes up, then it goes down. It’s really not that big of a deal yet our government leaders act like a recession or a falling stock market is the end of the world. There has been a recession in the US, on average, every 6 to 8 years since World War II. The last recession ended in 2009, which places a high probability that the next recession isn’t far off.
I bring this up because the global economic data has been deteriorating just about all year, to the point that I currently believe we’re in a (rather severe) global recession. The US economy has held up much better than the rest of the world but the strengthening US dollar has been weighing on US growth and inflation. Last week the ISM Manufacturing PMI Survey came in at 48.6, the first reading below 50 this year. A reading below 50 shows contraction, above 50 shows expansion. This highlights/confirms what the global economic data has been saying all year…
-Global exports (trade) are down over 15% year-over-year
-The Baltic Dry Index, which measures shipping rates of dry goods, is down 42% year-over-year to multi-year lows
-New Factory Orders: down 4.5% YoY; Non-durable goods orders: down 6.9% YoY; ISM Manufacturing PMI: reading of 48.6, down 17% YoY – I track these because they correlate well with future economic activity and stock market returns (employment data is extremely lagging):
-Commodity prices have been collapsing since the middle of 2014 and are now trading at levels below the low of 2009 despite supply cut backs, which indicates it’s a demand issue (sorry Janet Yellen, it’s not “transitory”)
-Credit spreads have been widening the past few months with serious red flags popping up in bank loans and junk bonds. CCC rated spreads are now near 2011 highs (first Euro crisis) and about to run to 2008 levels. Notice that they started rising around July, 2014 – the exact same time the US dollar started climbing…
-The headline reporting of US auto sales looks great but if you dig a little deeper it’s clear that they’re being driven by subprime lending (I guess we didn’t learn a whole lot from the housing debacle a few years back). As a side note, if you’re looking to purchase a new car in the near future, hold out for a year or so. I have a feeling we’ll be seeing some really nice sales to move the excess inventory. This is why we no longer own GM and I just cut Toyota in half.
These are serious signs of stress in the system (as bad as 2008) but you won’t hear CNBC talk about them (they’re not as sexy as “FANG” – Facebook, Amazon, Netflix and Google). It all boils down to one major factor – the US dollar shortage. There simply aren’t enough US dollars in the global system (the global money supply outside of the US) and it’s creating a squeeze and causing some major dislocations in the markets, things like swap spreads trading a negative rates since September (that’s a fairly complex topic so I won’t go into detail but wanted to mention it in case you’ve noticed it in the news). The Fed stopped the spout of easy money right after the US dramatically cut its purchases of foreign oil. Both ended the flow of US dollars into the global system which then led to a rising US dollar (large demand, little supply) and the global economy began to slow pretty rapidly.
And now the Fed wants to raise interest rates next week just to save face. Quite frankly, I don’t think it matters what they do at this point. I think they’re two years behind the curve and the credit cycle has already turned. This is how they’re backed into an unenviable corner. On one hand, they need to raise short-term rates to help the pension and insurance industry (not to mention retirees). But on the other hand, the IMF and Bank of International Settlements (BIS) are screaming at them “Are you crazy?! You can’t raise rates right now,” speaking about the havoc it will cause in the rest of the world, which the US is not immune to. Just about every other country is easing monetary conditions as they struggle with the shortage of US dollar funding, and now Europe is taking rates even further negative and increasing QE. By the way, keep an eye on the Swiss National Bank (SNB) this week. They pioneered negative interest rates and haven’t seen too many issues just yet. I think the ECB just forced them to lower rates even further negative again, and I’m sure other Central Banks are watching as a test to see if they’ll be able to do the same.
Personally, I don’t see how the Fed gets out of this mess without additional QE. I actually think they need to slowly raise short-term rates while anchoring the long end with more QE (essentially flattening the yield curve themselves). The next step we’re hearing politicians (mainly in Europe right now) discuss is to do fiscal QE – basically using the Central Bank to print money for government spending in the form of projects and direct handouts. We are absolutely through the looking glass… but it really is the only way to deal with the ridiculous amount of debt in the world, given the dynamics of our financial system, without outright defaults or overnight debasement of currencies.
What this all means is that interest rates in the US are going to remain low for a long time. I don’t know where the stock market will go moving forward but I do know that this is not an environment to be taking a lot of risk. The fundamental picture looks pretty scary at this point, but there’s always the Central Bank wildcard that, to this point, has been able to successfully keep things afloat. I’ve been adding to US treasury bonds on each dip in price and can only hope Janet Yellen gives us another opportunity to add more next week if she raises rates and we see a spike in yields (drop in bond prices).
-Nick
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