Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
“Self sustained” delusions…
For a second week in a row, the markets were brazen with confidence and visually selective regarding March economic data. Marginally decent data (if we can call it that) was celebrated while the bad data was summarily dismissed, propelling the S&P 500 to a 1.66% gain for the week. We believe the gains to be a function of Fed money printing, along with the notion that bad things are allowed to happen in the wake of Japan’s earthquake/tsunami/nuclear issues.
Among the data released: Personal Spending for February increased a handsome 0.7%, which the market loved in spite of a fairly large decrease in the savings rate. Non-Farm Payrolls (jobs created), which is a lagging indicator, registered 216K vs. 190K expected. Behind the curtain, however, the data didn’t improve. The Dallas Fed Manufacturing Activity fell to 11.5 from 17.5. The S&P/CaseShiller Home Price data declined—again. Consumer Confidence Levels sank for the first time since December. MBA Mortgage applications fell 7.5% as bonds continued to “leak”. ISM Prices Paid also rose again to 85.0 from 82, back to levels seen just before the 2008 crisis. Factory Orders declined 0.1% and Average Hourly Earnings (part of the employment figures) were flat for the month of March.
Beyond the US economic quagmire, there are plenty of reasons for the markets to give up their speculative pursuits: Moody’s downgraded the debt of both Portugal and Greece; Ireland’s bank “stress tests” confirmed the need for an additional $34B in funds to avoid bankruptcy; (Italy is rumored to be close to its own “bailout”); and the price of oil (now at $107.94) continues to soar for a myriad of reasons, not the least of which appears to be unsolvable issues in the Middle East.
Still, there seems to be some conviction that the economies of the world have reached a “self sustainable” level, and therefore warrant the need for central bank “tightening” if not outright withdrawal of stimulus from the system. The BOE, ECB and a growing number of Fed “dissenters” share this belief. Proposed actions include raising rates and or selling back into the market those assets “monetized” by central bank authorities since the crisis of ’08 began. Just so we are clear, QE here in the States, amounting to nearly $5 trillion ($7 trillion or more with the leverage) in the last 2 ½ years represents 20% to 25% of GDP over the same time period. Ending or even contracting QE would be like removing a wheel from your car and expecting it to handle the road, let alone the corners, without a hitch. Extending QE would be equally damaging in our opinion, as inflation continues to escalate—eroding corporate profits, not to mention consumer disposable incomes.
Instead, we suspect, tightening will come, but not to the degree required. Raising rates 25 or 50 basis points will amount to mere window dressing and may even serve to exacerbate the speculation now abound in the commodities markets. But this won’t stop the Fed from claiming to do the right thing at the right time, saving much needed face (or credibility lost) on the failed housing rescue. Somewhere down the road the Fed will be forced to get “tough”, but we’re of the mind that this won’t happen until the banks are washed of their “bad debts” and “inflation” is a common household word.
Metals agnostic or true believer?
There is a new Greenspan put. QE has taken over where the Maestro left off. But there is a significant difference between the monetary environment today and that of the 90’s. You knew then that if something went wrong, Greenspan would keep you solvent and the ramifications could be muted by Fed accommodation. Today, however, you see the Wall Street crowd reveling in the possibility of bad news. Why would Wall Street, the capital raising machine, the ultimate paper product pusher (stocks and bonds), risk this distribution empire on a bit of bad news? Well, without announcing it, Wall Street has shifted emphasis from raising capital for corporate clients (still a division of the business) to a focus on outright speculation. This is a significant turn of events because it helps explain why they are looking for the dark cloud in the sky.
While gold bugs have long looked for a day of reckoning where bad fiscal and monetary policies play out in some sort of market cataclysm, the Wall Street crowd now is anticipating something similar, dare we say “needing”, something similar. The sooner we receive a bad bit of news, the sooner billions, even trillions of dollars, will flow into current market-saving speculative bets of all sizes and shapes, or allow for more of those bets to be initiated. QE2 has been of great benefit to speculators the world over. If it goes away, so do the warm fuzzies that come with outsized gains. Lenin’s “Worse is better”, has taken on a decidedly mid-town style (not meaning to neglect the Hedge funds in CT).
We remain in an era where most investment professionals (not just the investing public) act upon a knowledge base forged in the better days of credit expansion and record debt accumulation. That was then. Now Fed monetization schemes are the lifeblood of the market. In the opinion of some, QE has succeeded. Your media giants like this idea most of all (advertising revenues strengthen with market enthusiasm).
In a radio interview this week with a regular CNBC commentator, I encountered the normal and expected advice, which like the generic can of soup on the shelf can be filling but may also kill you with regular ingestion (always check the label for sodium content). There was in the last equity bull market a little extra savor for the investing public. Credit was a key element. Credit like salt can preserve, but it cannot generate life. The closest we come to mirroring the Greenspan era speculative driven growth, is the aforementioned QE. These measures have extended an increase in equity prices, but have not yet generated anything self sustaining in the economy.
Among other things we discussed gold. The conversation centered on the pros and cons of ownership. To this man’s surprise, I led the charge in hurling insults at the yellow metal, including: “No interest paid”; “Costs dearly to own” (real estate investors should, I suppose, also be forewarned); and “Fails to capture the ingenuity and creativity of the human brain” (generally associated with buying a well run company).
While our initial conclusion was shared, “Over the long term, gold is a very poor investment,” our final conclusions were quite different. Every asset class goes through bull and bear markets for specific reasons, and these reasons should not be neglected. It is fair to say that in the alternating episodes of greed and fear in the marketplace, paper assets will do quite well for a time and then suffer greatly; tangibles such as gold, know the same fate. Better to be agnostic and recognize the trends for what they are.
Precious metals are in a 10-year bull market, yet that trend is still hard to swallow for some.
Reflecting on the cons of gold ownership raised during the discussion, we in fact discover in them many positives. To the “no interest paid” charge, we respond: “What interest were you being paid? Furthermore, if any interest at all was to be paid, at what risk (credit or inflation)”? To the “costs dearly to own” charge, we respond: “Is the storage fee of 1% or less that severe when set against an inflation target of 2% by the Fed wherein every dollar resting in a savings account is more or less “resting in peace”? The reality is that actual inflation dwarfs the official rate. And a negative real-rate environment has always been gold positive. As for the ingenuity and creativity objection (most recently issued by Mr. Buffet), we agree; when you can find those elements, you may invest knowing that the best and the brightest are backing the effort—but then again, it is the best and brightest, the truly ingenious, that have brought the system to its knees. Every once in a while there is a time to trust the system less and take more control of one’s assets. Gold excels in such an environment. (Don’t forget, we favor a metals position as insurance. More simply still, gold and silver are money).
As we conclude, a word of warning: we would be cautious between now and June. In our opinion, the Fed may claim success for their policies, and prematurely end QE2 (just shy of the 600 billion committed). Tactically (for publicity purposes) this proves their success and helps them claim an abiding sensitivity to inflationary trends (maybe they’ll throw in a ¼ point rate hike to boot- yawn). Can they abandon the QE course? No. This simply opens the door to QE3 as and when an externally driven event forces them back into accommodation mode. In this light it is a solely responsive choice, not a first choice, but one they can claim is driven by the desperate nature of events then unfolding. Continued QE needs to be legitimized, and that’s a tall order given current bond market vulnerabilities.
This is a game of perception management (credibility too I suppose). Bernanke, has to be seen as (that’s right, seen as) the fighter of all evil monetary monsters, deflation and inflation alike.
Have a great weekend.
President and CEO
VP Investment Management