Over the past several years, as the U.S. economy has generally underperformed mainstream expectations, it’s been my observation that when Fedwatchers start looking for tightening or (the modern equivalent) a withdrawal of extreme ease, it’s been a perilous time to be long stocks or short bonds for more than a brief period. We may be there again, as per the Bloomberg.com article today which exudes cautious optimism throughout (e.g., “We’ve got some momentum here”) and leads with:
The Federal Reserve will probably revise its pledge to keep interest rates close to zero through mid-2013 as the need for large scale asset purchases diminishes, according to economists in a Bloomberg News survey.
Anything can be, of course, but just in the past few days, we have seen big sales misses from du Pont, Texas Instruments and Intel; more and more evidence of negative economic growth in the U.K. and several eurozone countries; and a 5% year-on-year drop in industrial production in India. Why the sudden optimism?
After composing the above, retail sales numbers for November were released. They are preliminary but all of a sudden, the growth optimism embedded in the above article gave way to this much more cautious wording:
Retail sales rose in November at the slowest pace in five months, indicating faster job growth may be needed to spark the biggest part of the economy. The 0.2 percent gain in sales followed a 0.6 percent advance in October that was more than initially reported, Commerce Department figures showed today in Washington. Economists projected a 0.6 percent November increase, according to the median forecast in a Bloomberg News survey. Purchases excluding automobiles also rose 0.2 percent.
Retailers like J.C. Penney Co.are relying on discounts to drum up sales as the labor market and incomes struggle to improve. To maintain spending, consumers have had to draw savings down to the lowest levels in four years.
Much is in flux. Numbers are released and then repeatedly revised. Even the Germans, a few months ago, blithely announced that a “bad bank” had a net worth almost $80 billion greater than previously announced because of an “accounting glitch”- but no one was to blame.
In the 2007-8 period, I recall an expert stating that the five years from 2003-7 saw the fastest sustained economic growth globally ever. If as I suspect, much of that growth, including in the BRIC nations, involved a good deal of malinvestment and was accomplished using high-powered leveraged credit, then it would be no surprise that as European banks withdraw credit globally, a second global recession could be a severe one. As an example of what might prove to be malinvestment, the Brazilian mining giant Vale has been reported to be building a fleet of ships to send iron ore overseas (think China) that is a larger aggregation of vessels than the U.S. Navy maintains. If China’s economy now lurches into a construction rec(depr)ession, just think of how much sunk capital will have gone into preparing to feed a bursting bubble.
As everyone who accepts at least some of the insights of von Mises as being important knows, low interest rates aka “free” or at least “cheap” money/credit cause projects to be undertaken that would not be begun under more stringent criteria. I think that this has been true all over the world the last several years. Thus we have seen the blow-ups in bond yields in the weakest economies from very low yields to, seemingly overnight, what we think of as very high yields.
But 5-7% yields as the governments of Spain and Italy are now paying are not high yields at all. The benchmark 10- and 30-year Treasury bonds that trade on the futures market are 6% bonds. Just 20 or so years ago, the U.S. Treasury paid 9% rates to borrow. There was absolutely no question of insolvency back then. Those rates forced capital to be wisely allocated, and a strong economic performance ensued.
I’m increasingly of the view that with foreign economies and politics seemingly dominant and clearly at least very influential in markets that U.S.-based investors typically trade (munis excepted), not only is the future by definition unknowable, but so is the present, and so even is the recent past.
As the old proverb might be modified: ”May you live in unusually uncertain times”.
Addendum: Added post-Fed announcement of no policy change- for those keeping score, the above comments were intended to be a continuation of the stance I have taken and reiterated in recent posts. The point I would want to have stated more clearly in the closing two paragraphs would be, from a market perspective, that when facts and their interpretations are so fluid, that argues in my view for a cautious or bearish view, and one in which cash is no longer trash. For the nonce.