Wrangling over the debt ceiling in the U.S. took center stage for weeks and we look at the whole episode as a sad sign of the times. It will likely become ever more commonplace. Governments across the globe are fighting to continue deficit spending and politics has forced central banks to take huge gambles by buying up enormous sums of debt. It is a global Ponzi scheme and a game of currency debasement. Those who recognize the recklessness of these policies push back and are castigated by the many in the media and various pundits as if being upset about handing the next generation a horrific set of fiscal circumstances makes one a pariah or worse.
Our best guess is that those who favor these policies should expect more frequent pushback as it becomes obvious to most that they are not working and have unintended consequences. Common sense dictates that various vested interests will continue to argue over priorities because real money (as opposed to the printed variety) is scarce. Many will continue to argue that putting our heads in the sand is just fine and that our debt binge is not an issue. Nonetheless, government involvement in markets and the economy is just about all there is these days. Five years into a supposed recovery the Fed seems too fearful to even slightly diminish its QE program. Before QE began even one $85 billion asset purchase program would have been a huge deal, but now a monthly purchase of that sum is the norm!
It seems as though everything that the powers-that-be do is a contrived effort to keep stock markets from collapsing. We think the Fed pays lip service to employment and inflation, but determines its success by where the S&P 500 closes on a given day. We do not say that lightly! Someone needs to tell them that QE is simply creating more free reserves because banks are not lending. We point to recent dismal reports from retailers, restaurants, and trucking companies as proof of policy ineffectiveness. At the same time, we know we have never could have imagined that so many stocks could trade at levels that reflect a robust business environment, yet the reality of their revenues and earnings paints a starkly different picture. This reality gap is a hallmark of monetary policy and one that must be resolved. Perhaps that will happen with a flat equity market for years without a major correction, but expecting that scenario would be betting against about a hundred years of market history.
We think we are caught in this paradigm that requires the Fed to buy up Treasury debt largely because it creates a ripple in the market pond that causes investors to keep doing foolish things like buy equities at some of the richest valuations in market history. We have no way of knowing how long this powerful belief in magic can continue. We know a lot of money has been lost in years past during prior Fed easing cycles because sooner or later fundamentals take over. Many are relying on one year’s worth of expected earnings to make investment decisions. That often does not end well, particularly when profit margins are dramatically above long-term averages and revenue growth is hard to come by. We really do believe that the Fed has lost all credibility and simply targets the S&P 500, but many know this now and believe they can exit before the party stops. We have no way of guaranteeing that with our capital and cannot take the risk.
Janet Yellen has gotten the nod to head the Fed, so don’t look for any changes in monetary policy. She may talk about shrinking the enormous $85 billion monthly purchase plan. She may even try it for a period of time….until stocks correct 10% or so. In fact, if it’s possible, we suspect that she will be even more accommodative given her public comments and demeanor. She, like Bernanke, really believes the Fed can create employment in the face of structural issues that are beyond her control. Many of the unemployed remain so because there are not enough of the types of jobs created by the Fed’s last bubble in housing. Given the cruel nature of markets, it is likely that money printing will continue until QE becomes the two most loathed letters on the planet in coming years. Based on history, it is the expected result given the tremendous accolades now being piled upon the academicians at the Fed. Greenspan was a celebrated legend before the tech bubble burst in 2001. Of course, Bernanke has been given recent credit for saving the world after the housing insanity which he helped create, but he was far from rock star status right after the 2008-09 crash.
The equity market is a market of individual stocks. In the end, the dynamic has become one in which faith in the magic of QE is pitted against the reality of individual company earnings reports. We strongly suspect that over the coming quarters too many companies will disappoint investors, causing their stocks to swoon and ultimately taking indices with them. We invest based on valuations, so we worry ourselves with what we can control. The Fed is either going to keep pumping dollars into the world or it is not. Investors are either going to persist in their belief that QE will magically boost stocks or they will become worried that QE is not helping the real economy as free reserves build and money velocity continues to crater. We do know that earnings have begun the process of rolling over and it is inordinately difficult to find equities to purchase.
We also know that QE punishes savers who would without a doubt have more disposable income if the Fed were not guiding all into riskier assets at rich prices. We suspect that Fed policy makes capital cheap for businesses and labor expensive, yet the FOMC wonders why employment is stagnant. We also know that it must be impossible for many businesses to conduct long-term planning because everyone knows that just about nothing in the current economic environment is organic or sustainable.
We are not paid to be optimists. We are paid to be realists.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.