Editor’s Note:
In this series of articles, we include important or interesting
videoclips with our comments. This is an article that expresses our
personal opinions about comments made on Television and in Print. It is
NOT intended to provide any investment advice of any type whatsoever.
No one should base any investing decisions or conclusions based on
anything written in or inferred from this article. Investing is a
serious matter and all investment decisions should only be taken after a
detailed discussion with your investment advisor and should be subject
to your objectives, suitability requirements and risk tolerances.
1. A Punt by Bernanke or Game over for Bernanke?
On July 13, we made an appeal to Chairman Bernanke:
- “Our humble appeal to Chairman Bernanke is to reduce QE purchases on July 30.”
We didn’t expect him to listen and he did not. Actually, he went the other way if this Wednesday’s FOMC statement is a true reflection of his feelings.
When we read the statement and watched the post-FOMC action in the bond market, we felt that the Fed was telling us to forget taper. Why? Read the key statements below:
- “… inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable”
- “The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term” .
Any one who has tried to follow or understand Bernanke knows that deflation is his worst nightmare. His determination to throw money aggressively to prevent even expectations of deflation from talking hold earned him the title “Helicopter Ben”. Even as jobless claims & other data kept coming in stronger, the PCE deflator, the Fed’s favorite inflation indicator, kept sliding lower. That alone was probably sufficient for Bernanke to back away from beginning a taper. Because he knows, despite his vehement protestations, that tapering is tightening.
Our appeal to Chairman Bernanke had a fundamental as well as a quantitative basis:
- “Chairman Bernanke, you have two tail winds behind you – the 195,000 payroll number of July 5 and the drastic cut in the budget deficit that is coming. One gives you the fundamental case for reducing QE and the second the quantitative case. And you can still argue that your monetary policy remains highly accommodative”.
With Friday’s weak payroll number of 162,000, Chairman Bernanke lost his fundamental tailwind. Unless payroll numbers for both August and September rebound strongly & the rest of the data remains strong, Bernanke will not begin a taper on October 30. Then it will be game over for tapering because the mid-December FOMC meeting will be mainly ceremonial for Chairman Bernanke.
This is essentially what Robert McTeer, former Dallas Fed President, said to CNBC’s Maria Bartiromo on Wednesday, afternoon:
- “well, I didn’t hear mention of tapering. I think it pushes it out just a little bit. I don’t think it’s going to happen real soon. It may be announced in September, but the economy’s too weak right now, and that was confirmed with the GDP numbers this morning. You don’t have that strengthening yet that’s a requirement for the tapering.”
- “[chance tapering doesn’t begin before Bernanke’s term ends] – yes, I think that’s very possible. I think we’ll hear some kind of announcement before his term ends. But it may be pushed out beyond his term.”
Larry Kudlow, ex-economist & CNBC’s erudite anchor concurred in his tweet on Wednesday:
- Larry Kudlow @larry_kudlow – The #Fed will not taper in Sept, and maybe not till next year. NGDP only 2.9%. Today’s #FOMC was dovish. #TCOT
2. Are Higher Treasury Yields Inherently Deflationary?
The answer is heck yes, especially when yields spike fast & furious as they did since May 2, 2013. Recall what Treasury yields did on July 5, 2013 – the previous payroll Friday:
- 30-year yield rose by 20 bps to 3.7%, an increase of 31% since May 1, 2013; 10-year yield rose by 22bps to 2.73%, an increase of 66% and the 5-year yield rose by 18bps to 1.60%, an increase of 146% over the 5-year yield on May 1, 2013.
Speed Kills! And this was the fastest percentage rise in relevant memory (see sections 3 & 4 of our July 6 article). A steadily growing economy with fundamental inherent strength can handle a large yield increase as in 1994. The leveraged economy of 2007 could not handle a much smaller and less spiky yield increase. Can the 2013 economy, still a leveraged post-bubble economy, handle the fastest spike in yields in the past 3 decades?
We think not and the recent data on refinancings & auto loans support our contention. The sudden, steep spike in yields in a span of 2 months is bound to increase deflationary pressures in the 2013 economy, in our opinion.
Clearly the Chairman thought so and that is why his statement mentioned [low] “inflation” in every single paragraph and did not mention tapering even once.
3. Disconnect between Fed Intentions & Bond Market’s Expectations?
Looking back, wasn’t the Treasury market actually signalling this decision since July 5? What is the maturity most sensitive to the Fed’s policy? The 5-year Treasury. Notice it peaked on July 5 at 1.60% and never saw that level again; not even on August 1 in the midst of stock market breaking out and TLT falling by 2%. The 5-year Treasury yield closed on Friday at 1.36%, a far cry from the peak yield of 1.60% on July 5.
Unlike the 5-year, the 10-30 year sector is governed mainl
y by the bond market. On Thursday, the 10-year yield closed at 2.71%, just 2 bps short of 2.73% level of July 5 and the 30-year yield, solely the preserve of the bond market, closed on Thursday at 3.75%, actually 5 bps higher than the closing yield of 3.7% on July 5.
In other words, the maturity most sensitive to the Fed dropped significantly from its July 5 level while the maturities most sensitive to the bond market touched their July 5 peak levels on Thursday, August 1.
Doesn’t this point to a disconnect between Fed’s intentions and the Bond Market’s expectations? How will this get resolved?
4. Who is in Control? Fed, the Bond Market or Data?
We saw the answer on Wednesday, Thursday and Friday. The ADP data on Wednesday morning came in strong but the GDP data came in mixed. Treasury yields reacted to the strong data in the morning but reversed after the FOMC statement on Wednesday afternoon. The data on Thursday morning was rabidly strong with jobless claims falling to a 2-year low while the ISM hitting a 2-year high. The Fed statement was forgotten and the bond market took complete control. Treasuries were SHOT and yield spiked to close near July 5 peak levels.
Then came Friday and now the Fed & Bond Market were in sync bot not totally in sync. The Fed-sensitive 5-year yield fell more than it had risen on Thursday; the 10-year yield fell almost as much as it had risen on Thursday but the fall in the 30-year yield was only about 60% of its rise on Thursday. Translation? The bond market is still not completely convinced that the Fed action was correct.
How & when does this get resolved? When the Economy vs Economy question gets answered. As we discussed last week, the job numbers have been strong but the others numbers like ISM, GDP have been much weaker. Which of these two sets of numbers will converge towards the other?
Thursday’s data seemed to give a definitive answer with both ISM & Jobless Claims coming in very strong after Wednesday’s strong ADP number. But Friday’s crummy payroll report has reinvigorated the Economy vs. Economy debate.
So who remains in control till September’s Fed meeting? The Data until the Economy vs. Economy question gets decisively answered.
5. Goldilocks? Dream from an Investment Perspective?
David Tepper used the term “goldilocks” in his famous “taper would be bullish” commentary on May 14 on CNBC Squawk Box:
- “I hate to use this word because it will come back to haunt me in life. for all these bears out there, we may be, a little bit of goldilocks right now. We just may be there.”
Mark Kiesel of Pimco used the “goldilocks’ term on this Friday. Actually Kiesel went further and called today as a dream for investors (see section 6 below):
- “the big picture is it’s kind of goldilocks scenario
because you’ve got a real economy growing at 1.5 to 2%. that keeps
central banks running high. very easy policy. that supports many sectors
of the economy. like autos, airlines, energy, housing, so in fact from an investment perspective, this is a dream.”
Remember what happens in a goldilocks scenario? Both Bonds and Stocks rally. The S&P is already up 20% this year while the Bond market has fallen in TLT terms by 14% and in EDV (zero-coupon ETF) terms by 20% since May 1, 2013. For this to be “goldilocks”, shouldn’t bonds rally now?
The majority of those who disagree with “goldilocks” are believers in strong second half growth in U.S. and in Europe, sort of like Tom Lee of JP Morgan ( see clip 2 below). Except Lakshman Achuthan of ECRI who tweeted thus on Friday:
- Lakshman Achuthan @businesscycle – Real GDP growth falls to 1.4% yoy, never this low in 56 yrs except around a recession.
Mr. Achuthan’s scenario would also close the performance gap between S&P & Treasury Bonds, wouldn’t it?
6. U.S. Bond Market – Guru Opinions
Julia Coronado of BNP Paribas on CNBC Closing Bell on Fed day, Wednesday:
- I think that for interest rates, we’re going to be pretty range-bound for a while. We may even see rates drift a little lower in the near term if the Fed confirms that, in fact, tapering is beginning to be pushed back. So I think the rapid backup in rates and the noted mortgage rates in the statement certainly is a concern to them with an economy that’s running at about 1.5% in the first half of the year. so they decided not to take any chances, and what they didn’t say spoke volumes. I think tapering in December would be the very earliest they would announce it. And so, what that means is probably — it’s probably good for the stock market and probably good for interest rates, as well. .
Jeff Rosenberg of BlackRock on CNBC Closing Bell on Wednesday, Fed day.
- “the debate … is the pace of increases in interest rates here. The question is, how much can the economy really support those types of increases in interest rates? And clearly, the GDP figures, while better than expected, 1.7% headline, this is still a very weak recovery. We can’t afford that degree of increase in interest rates, it’s as simple as that”.
Mark Kiesel of Pimco on CNBC Fast Money on Friday:
- “the bigger picture is really the policy rate and growth. Pimco sees a 2% real growth forecast. The Fed actually sees in 2014 to ’15, a 3%-3.5% forecast So with we differ from the market or the Fed. We don’t think growth is that strong globally. We see a low inflation rate, and in fact, we don’t see that strong of a labor market. So all this in our view, means the bond market a t these yield levels is very attractive.”
- “We’re underweight the long end of the yield curve.”
- “the big picture is it’s kind of goldilocks scenario because you’ve got a real economy growing at 1.5 to 2%. that keeps central banks running high. very easy policy. that supports many sectors of the economy. like autos, airlines, energy, housing, so in fact from an investment perspective, this is a dream.”
- “[10-year yield] – we think they’re going to head down towards 2.25% to 2.5%. .. the market is overshot due to technicals. we don’t see the job market gains more than 150,000 to 175,000, which by the way, means the unemployment rate particularly as people come back to the labor market doesn’t come down as fast as it has over the last two years, which means the policy rate stays much longer and the intermediate part of the bond market is attractive.”
- “[better value in bonds of the homebuilders versus the equities right now?] – yes, and also, within the housing related sector, we are favoring specifically companies like whirlpool appliances, building materials companies like — home improvement like usg, lumber companies, weyerhauser and the reason is that the remodel cycle is just starting. housing starts basically bottomed about a year and a half ago. remodel is just kicking in and who’s going to benefit from that? whirlpool, those are the companies to own. not the homebuilders”
7. U.S. Equities – Guru Opinions
Thursday was a terrific day at least in the indices with S&P crossing 1,700 first time in history. Not only did S&P and Dow Transports break out but so did the market’s multiple per Bespoke’s tweet on Thursday:
- Bespoke @bespokeinvest – Along
with a breakout in price today, the S&P 500’s trailing 12-month P/E
ratio also broke out to a new multi-year high up to 16.40
What did Ralph Acampora say just after the close on Friday?:
- “we’re at an inflecion point and I say that because the leadership here has been the Russell 2000, Russell 3000, growth in value and mid cap value. that’s a sign of confidence and something we’ve been waiting for. the public is coming in, Maria. … I think this market shows it has a lot of resiliency. You saw it again today. Up, Up, and Away.”
- the market is a discounting function. we’re at all-time new highs. what is the market saying? the market is saying the future’s going to be better, brighter. come on, guys. It doesn’t get much better than this.
Tom Lee , the man with a 1775 target for the S&P, said on CNBC Fast Money on Thursday:
- I think there’s
data showing the U.S. is accelerating. … I think the data is showing Europe is improving. you
got a case for higher earnings and if people feel like earnings can go
up they can raise the multiples. So you have an e-story and a PE story - I think Europe is tracking toward acceleration 100, 200bps higher than the 1st half, basically exiting recession. Our European guy sees huge opportunities for multiple expansion there.
Lawrence McMillan was his consistent self in his weekly commentary:
- “In summary, despite what had appeared to be an overbought market, only one minor sell signal developed from our indicators, and now $SPX is making new all-time highs once again. So, until there is some visible break in the uptrend, we remain bullish.”
Not everyone was positive. .
- Abigail Doolittle @TheChartress – It “felt” like the last week of July/first two weeks of August 2007 about 6 weeks ago, now it feels like mid-September 2007 #froth
8. Is Non-Tapering really Easing?.
If tapering were not tightening, then why would Bernanke have cancelled his tapering plans? And why would the taper increase deflationary fears? Bernanke’s dovish statement and his refusal to commit to a tapering decision and our two simple questions demonstrate that tapering is indeed tightening, despite what Fed guys and their Fin TV friends have said.
Today, we raise a contrapositive question – Is Bernanke’s Non-Tapering really Easing?
People would laugh and argue that non-tapering is merely reverting back to status quo. Those people forget the warnings by David Tepper and Larry Fink. These two masters have warned investors that the Treasury will have no choice but to reduce issuance of treasury securities because the deficit is literally melting away. Larry Fink explicitly said on July 10:
- “I would .. just as worried if the FED does not slow down purchases as the same time treasury reduces issuance. The FED would then be buying 130% of new issuance.”
So if Bernanke refuses to “taper” this year, then his effective QE would be 30% higher as a ratio of Treasury issuance than it is now. Meaning Bernanke would be adding 30% higher stimulus to the bond market. Surely that would qualify as a large easing of monetary conditions, wouldn’t it? That is why we think Bernanke’s refusal to taper is really a further significant easing of monetary conditions.
Ergo, Non-Tapering is Easing.
Featured Videoclips:
- Dani Babb on CNBC Fast Money on Thursday, August 1
- Tom Lee on CNBC Fast Money on Thursday, August 1
1. “another Bubble in the making” – Dani Babb on CNBC Fast Money – Thursday, August 1
Ms. Babb is the CEO of The Babb Group, a firm that represents $5 billion in investor funds, per CNBC. Her message is outspoken and out of consensus.
- 4.33% – 4.5% for the foreseeable future in terms of the 30-year fixed interest rate [mortgage]. This market is very dependent on first time home buyers who, as you pointed out, have been on the sidelines for some time. They’ve represented about 28% of sales in the last year. In a healthy market it’s about 40% so it certainly is putting a damper on home sales which I actually think is a positive thing and I’m concerned about first time buyers jumping into the market.
- I think we have another bubble in the making. We’re seeing a lot of numbers that are reminiscent of 2005 and 2006. Concerned about the price stability & the ability to maintain the price momentum we’ve seen over the last year that’s largely been driven by very low interest rates. We had a bubble last time driven by very easy credit. We have bubble this time potentially driven by very cheap credit over a long period of time
- We still have unemployment at about 7.5%. the Fed’s is looking for 6.5 before making some serious moves. We’ve got a median price that’s grown 13% since last year and that is the highest % gain since 2005. If all other factors hold the same, are consistent and we expect similar types of gains over say of maybe one to three years we could see prices back where they were again.
- We’re already seeing some signs of that in Miami, Boston, California where we have got 65% of purchases made in cash by investors. For example, the South Beach and Miami markets are heavily overheated and in price wars an average of 10 to 15% over asking price for purchases.
2. target 1775 – Tom Lee on CNBC Fast Money – Thursday, August 1
Tom Lee of JP Morgan has been one of the most bullish strategists on the street.
- it’s great that we closed above a round number milestone. 1700 is a big number. I feel comfortable thinking you can buy the market today and still get pretty good returns into year end. Because, one, I think there’s data showing the U.S. is accelerating. Obviously tomorrow is the most important number. I think the data is showing Europe is improving. You got a case for higher earnings and if people feel like earnings can go up they can raise the multiples. So you have an E-story and a PE story
- the taper is going to have to address the question of position squaring. I think the market, the participants are way overweight fixed income. if they start to think interest rates are going up, I think that money comes out and hopefully goes into equities. On equity side, we think taper happens because economy is strengthening. you’ve got a case that the e could offset volatility in the pe.
- in Q2 one of the things
everybody might be surprised, 72% of companies generated better top line growth in the quarter, the best number since Q1 2012. I think the multiple people are showing to pay what they’re paying for staples stock right now which is 18 to 20 times. If they are willing to own bond-like stocks, maybe the cyclical market can rerate the smokestacks, the techs, industrials, financials. - we are we have the least insight about Asia. If we felt there was a deeper deceleration in China, that could put a lot of concerns out there. Europe as important as it is and as helpful as it is, if we see something weakening in Asia, it may be more than offsetting.
- [Europe] we have had a lot of discussion about this today internally. I think Europe is tracking towards acceleration. 100, 200 basis points better than the first half, basically exiting recession.but are you better off buying a European stock or a U.S. company with a lot of leverage to Europe. I know our European guy sees huge opportunities in multiple expansion there.
