Hulbert on Rate Hikes & Stock Market; a Response

Federal Reserve,

Mark Hulbert has a piece this morning at MarketWatch in which he de-correlates the first Fed interest rate hike from any supposedly corresponding stock market movements.  I agree with some but not all of what he writes.  Let’s take it a chunk at a time.

Investors, it doesn’t matter when the Fed raises rates

Are you obsessed with whether the Federal Reserve will begin to raise official interest rates in July, September or sometime next year?

No.  I’ve wanted them to do it for years now.  So I’m obsessed with why the Fed refused to raise rates, despite a strong economy and inflation signals that were not nearly so tilted toward the dis-inflationary end of the spectrum as they are now.  I am obsessed with wanting to know why the mainstream media and financial establishment even take their oh so heavily anticipated policy decisions each month seriously.  I am obsessed with the all too obvious underlying message that this is all about a stock market ‘wealth effect’ that eventually trickles a little stream down Main Street, with Grandma and other prudent savers thrown in the gutter.

A review of historical data fails to find significant statistical support for believing that higher rates are in themselves bad for the stock market. And even if they were, the difference of a few months in the timing of increases makes little difference when determining if equities are expensive or cheap.

I concede that both of those beliefs are far from conventional wisdom on Wall Street. But the job of the contrarian is to challenge norms.

Agree.  But I am not sure why Mark is using the 10-yr yield in his article.  With the Fed at work on all parts of the curve, the whole thing is corrupted and not subject to extrapolation of historical data anyway.  But insofar as it would be, why not use the Fed Funds rate or the 3 Month T Bill?  This chart from NFTRH has clearly shown that rate hikes did not matter to the stock market for extended periods on the last 2 cycles… until of course, they suddenly mattered… big time.

irx

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Pivotal Events

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Guest Post by Bob Hoye

pivotal.events
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US Dollar is Wandering Off Track

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Guest Post by Tom McClellan

Dollar Is Wandering Off Track

Fed Funds versus Dollar Index
January 29, 2015

It is widely believed among economists and currency analysts that currency values follow the relative interest rates.  We are told, “Money goes where it is treated best”, and so the currency which offers the best interest rate will attract the most capital.

But that does not really explain what has been happening over the past year.  The US Federal Reserve has kept short term interest rates near zero, and just about every other central bank around the world has done the same.  But the US Dollar Index is up 16% versus January 2014.  So clearly the microscopic differences in interest rates do not explain this behavior.

If you were to look at a coincident chart of the Fed Funds rate versus the Dollar Index, it would be tough to prove that there is any real-time correlation at all.  But people still think that such a correlation exists, and so they imprint their beliefs about what interest rates are going to do onto their expectation of what the currency will do.  The expectation that the Fed will raise rates ahead of the European Central Bank (ECB) has pulled a lot more wealth into the dollar, boosting its value versus the euro.

But the belief that a relationship exists between interest rates and currencies is not completely wrong.  The key to unlocking that relationship lies in seeing the lag time involved.  This week’s chart helps to explain that relationship better.  The plot of the effective Fed Funds rate is shifted forward by 3 years to reveal that the Dollar Index tends to follow in the same footsteps 3 years later.  So yes, interest rates matter, but not for 3 years.

Interest rates are not the only factor which matters.  Other topics will come along from time to time, and occupy investors’ attentions.  This perhaps explains why we are seeing a rally in the Dollar Index now, even though the Fed Funds rate has been flat for several years.  If one believes the legitimacy of this interest rate model, which has over 40 years of history to demonstrate its prowess, then there has to be something wrong right now.  Either the Fed is stomping on the useful message from the bond market by engaging in price-fixing of the cost of money, or else the Dollar Index has no business being way up here.

My inclination is toward the latter hypothesis.  The US economy is supposedly great, and worthy of a high currency valuation.  But real employment numbers (not the massaged government ones) are not that great.  And the falling oil prices will hurt the portion of US GDP related to oil production, whereas western Europe stands mostly to benefit from lower crude oil prices with no downside since the countries of western Europe hardly produce any oil.  So this excursion off track by the US Dollar Index is likely going to have to get given back.

At the point when the Fed finally does start to raise rates, then we can start the 3-year clock for a real rise in the dollar.

What’s Bigger Than the $1.4 Billion Mortgage Ratings Scandal?

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Guest Post by Elliott Wave International

What’s Bigger Than a $1.4 Billion Mortgage Ratings Scandal?

The great “inflated” expectations for gold, oil, commodities — and now stocks

Editor’s Note: You can read the text version of this story below the video.

 

On January 21, one of the biggest financial lawsuits in recent history came to a costly end. The accused, ratings behemoth Standard & Poor’s, agreed to a $1.4 billion settlement for “inflating credit ratings on toxic assets,” thus accelerating and exacerbating the 2008 subprime mortgage crisis.

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Pre-Packaged Baloney

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Guest Post by Michael Ashton

Ten-year nominal rates continue to drift back towards the 2012 lows; the 10y Treasury yields only about 1.75% now. But 2015 is so very different than 2012 in terms of the cause of those low rates.

Nominal bonds are like the packaged sandwich you pick up at a gas station: no special orders. You get the meats in the proportions they were put on the sandwich; in the case of nominal bonds you get real yields plus inflation expectations and the nominal yield moves the same amount whether the cause is a change in real yields or a change in inflation expectations. If you buy nominal bonds because you think the economy is growing weak, and you’re right but at the same time inflation expectations rise, then you’re out of luck. You get what’s in the package.

If you look beyond the packaging, to what is making up that 10-year yield sandwich, then the difference between 2015 and 2012 is stark. When 10-year nominal yields were at 1.50% back in 2012, 10-year real yields were at -0.90% and 10-year inflation expectations were around 2.40%. The bond market was pricing in egregiously weak real growth for the next decade, coupled with fairly reasonable inflation expectations. TIPS were clearly expensive at the time, although I argued that they were less expensive than nominal bonds. (In fact, I may have said that they were expensive to everything except nominal bonds).

Today, on the other hand, nominal yields are low for a different reason. TIPS yields, while low, are positive (10-year real yields are 0.13% as I write this) but inflation expectations are very low. So, in contrast to the circumstance in 2012, we see TIPS as very cheap, rather than rich.

One way to look at this difference in circumstance is to study how the proportions of meats in the sandwich have changed over time. The chart below (source: Enduring Investments) shows the percentage of the nominal yield that is made up of real yields. The percentage which is made up of inflation expectations is approximately 100% minus this number, so one chart suffices. Back in “normal times,” real yields tended to make up 40-50% of nominal yields.

real10ratio

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Get Out of the Casino!

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Guest Post by David Stockman & Stealflation

Today’s [yesterday’s –ed] Dip is a Warning – Get Out of the Casino!

Shortly after today’s open, the S&P 500 was down nearly 2% and off its recent all-time high by 3.5%. But soon the robo-machines and day traders were buying the “dip” having apparently once again gotten the “all-clear” signal.

Don’t believe it for a second! The global financial system is literally booby-trapped with accidents waiting to happen owing to six consecutive years of massive money printing by nearly every central bank in the world.

Over that span, the collective balance sheet of the major central banks has soared by nearly $11 trillion, meaning that honest price discovery has been virtually destroyed. This massive “bid” for existing financial assets based on credit confected from thin air drove long-term bond yields to rock bottom levels not seen in 600 years since the Black Plague; and pinned money market costs at zero—-for 73 months running.

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FOMC Statement

Federal Reserve

For all you speed readers out there…

Release Date: January 28, 2015

For immediate release

Information received since the Federal Open Market Committee met in December suggests that economic activity has been expanding at a solid pace.  Labor market conditions have improved further, with strong job gains and a lower unemployment rate.  On balance, a range of labor market indicators suggests that underutilization of labor resources continues to diminish.  Household spending is rising moderately; recent declines in energy prices have boosted household purchasing power.  Business fixed investment is advancing, while the recovery in the housing sector remains slow.  Inflation has declined further below the Committee’s longer-run objective, largely reflecting declines in energy prices.  Market-based measures of inflation compensation have declined substantially in recent months; survey-based measures of longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.  The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate.  The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced.  Inflation is anticipated to decline further in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate.  The Committee continues to monitor inflation developments closely.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate.  In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation.  This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.  Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.  However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated.  Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.  This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.  The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Jeffrey M. Lacker; Dennis P. Lockhart; Jerome H. Powell; Daniel K. Tarullo; and John C. Williams.

Why Jim Rogers is Wrong

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Guest Post by Capitalist Exploits

“If you’ve got young people who don’t know what to do, I’d urge them not to get MBAs, but to get agriculture degrees,” – Jim Rogers

“All your viewers who got MBAs made a terrible mistake; they should try to exchange them for farming degrees or mining degrees”. – Jim Rogers speaking to a Bloomberg anchor

In 2004, Jim’s book Hot Commodities was published. In the book he focuses specifically on sugar and coffee due to favourable supply demand issues. Over the few years following publication both commodities rallied hard producing gains of 155% and 232% respectively.

We did not disagree and discussed Input Capital and their agricultural streaming model which we really liked and still do. We discussed opportunities for traders in “The Ag Trade” where Mark discussed specific trading strategies he was employing.

Agricultural Commodities

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Response to Kyle

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[edit]  It’s a little promo-ish, but I did not solicit it and the whole back and forth is important IMO in delineating the boundaries between b/s and rationality…

Gary – I just wanted to say thank you for your very thoughtful public response to my email. I honestly don’t know of anyone else like you who would take the time to do that.

By the way, I like and appreciate your candid style of writing. I would be upset if you ever changed. Your willingness to call it like you see it is refreshing and why I became a subscriber.

You are right. There probably isn’t much on which we disagree, but certain things irk me and I feel the need to say something. I just can’t stand the emphasis placed on the dollar index, which is a completely made-up basket that essentially measures the “strength” of crappy green paper versus other colorful pieces of worthless paper. It’s silly.

That said, I do understand now what you were saying. Yes, people have been fooled into buying commodities and related equities in anticipation of a “dollar collapse.” That is true. Anyone holding coal, iron ore, copper, or oil stocks has been wiped out. And the Sinclair predictions for $50,000 gold and hyperinflation call from John Williams of Shadow Stats by such and such a date are quite lame and not credible at all.

Anyway, I hope you don’t change the way you write one bit. You are like a refuge for us in this age of non-stop BS propaganda.

As posted at NFTRH.com…

With his kind permission, I would like to publicly respond to a critique I got from subscriber, Kyle. This is not the first bone he has had to pick with me and if I am doing my job well, it won’t be the last that either he or others pick. Now, pissing off subscribers (my customers) is not something I want to do routinely, but I have a way of communicating that is just that, my way of communicating.

In that communication there are all kinds of buzz words and phrases I’ve made up, like Armageddon ’08, Inflation onDemand, Fiscal Cliff Kabuki Dance and probably 50 others over the years that just popped in my head and got popped right down into NFTRH, the websites or both. Then there is the Federal Reserve and the Outer Limits shtick and a hundred different ways to flog Fed officials (Good Cops/Bad Cops, etc.).

Those instances noted above don’t seem to upset people, but when I mention cults it starts getting dicey because so many of us identify ourselves, through ideology, to firmly held beliefs and cults well, they depend on an ideological grip on their members.  [edit] FWIW, I have my own firmly held beliefs, but I consciously try to make sure they don’t screw me up when managing the markets on an interim basis.

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Deflation

Deflation,

We have deflation of footballs and deflation of my lungs after round 1 out there in the driveway.  Back in and taking a break, I always find Jeff Gundlach an interesting listen.  Maybe you will too… Pardon the ad if one pops up in the 1st 30 seconds.