Twenty years ago, at my prior firm, my portfolio manager partner and I sat across the table from a then recently departed member of the FOMC in the offices of a major brokerage house in New York. He tried to convince us that if the Fed wanted the price of crude oil to be $100 per barrel, then it would be $100. Because oil was trading at around $25, I was quite skeptical of the possibility that the Fed could pull off such a maneuver. I vigorously stated my belief that the laws of supply and demand would eventually confound the Fed’s efforts at manipulation. I also asked why it was wise or desirable for the Fed to exert such control over oil or markets here that were relatively free compared to others across the globe. After all, the U.S. powers-that-be would not want to travel the road of their then derided Japanese counterparts who had daily attempted to influence securities trading.
The fact that this guy had so badly missed seeing the onset of the 1990-91 recession when he was still on the FOMC caused me to wonder why he was so confident. He was very animated to the point of being comical in arguing that the Fed had the power to control the price of just about anything. The conversation went on for thirty minutes or so until my salesmen at the time politely intervened (as any good salesmen feels compelled to do in a somewhat heated situation). I have thought quite a lot about that incident recently and question just how long the Fed’s current power over equities, which we term “magic,” can last.
We have recently written about the power of the main stream media/Fed script for 2013 and current data and corporate news have further convinced us that we are on to something. Employment data for December was terrible and many retailers and restaurants had weak Holiday sales based on company comments, yet the pundits are singing “happy days are here again.” December auto sales were softer as well and inventories are quite high according to the CEO of AutoNation. The talking heads just blame the weather (we do agree it played a part). However, the big picture remains the same: secular weakness from debt burdens continues to dampen growth in a big way. An S&P 500 over 1,800 is not indicative of an economy susceptible to some ice and rain. For goodness sakes, the number of people who have left the workforce soared to almost 92 million in the U.S. in 2013. Yet because the media and the Street stick to a positive storyline, the Fed’s grand QE experiment has pushed equity bullishness to historic extremes in the face of the lowest labor force participation rate in over thirty years.
The dramatic Baltic Dry Index collapse thus far in January seems to indicate global trade remains soft into 2014. Today we heard this from one of our best sources, Fastenal (FAST), a key player in construction and other industries:
“In Dec 2013 we issued a press release intended to provide an update on the fourth quarter of 2013. This is only the second time, in our 26 years of being a public company, we have taken this step. Our goal is to keep this type of communication very rare. We took this step because our December sales trends were weak, but, more importantly, because our gross margin trends were deteriorating. In the days following our release, our sales and gross margin trends continued to weaken. This weakening was worse than we expected and this created additional drain on our ability to grow earnings.”
Housing is a sector that is supposed to lead the way, yet Wells Fargo and the other major players are enduring a brutal collapse in their mortgage businesses.
My skepticism of Fed power from that meeting twenty years ago has been tested to say the least by the events of 2013. Last month in this letter we introduced Ben Strong, a once celebrated Fed figure of the 1920’s. I have often wished his ghost could have been with me on that day long ago in Midtown Manhattan as I debated the wisdom and limits of central bank activism. Investors of that past era believed Mr. Strong could do no wrong when markets roared as he provided extreme liquidity. Many behaved as if economic downturns had been eliminated until 1929 arrived and even some of the luminaries of finance suffered devastating losses because they had abandoned discipline. Suddenly that Ben did not look so bulletproof. But what of our Ben? Well, if 2008-09 did not make clear the fallibility of the modern Fed, then perhaps nothing will. For months in 2008, as the housing market came unglued, the accepted wisdom was that Fed accommodation would prevent a market collapse. It didn’t.
Scott Brown, CFA, Founding Partner
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.