We see our central bank and the financial markets beholden to it as in a gargantuan bind brought on by years of monetary experimentation that is not producing optimal results for most of the population to say the least. The Fed’s desire to shift to a tighter stance is about two years too late, making it woefully out of step with the underlying or true economy as opposed to the speculative economy. This speculation was given a new birth in recent years by a stubborn refusal to see that QE might be causing horrific distortions that made things worse in the long run. Nonetheless, given our positioning, we are almost ambivalent about the Fed rate hike false drama.
Comments from Fed head Yellen in recent days seem to indicate she is now worried about high stock valuations and euphoric credit market issuance levels. Other influential members of the FOMC are “jawboning” about raising short rates in a weak attempt to return some rationality and normalcy to markets. They seem to have finally recognized the “monster” they have created. Encouraging corporations to issue massive amounts of debt in order to fund stock buybacks has not been pro-growth, but it has been one of the most significant direct results of current policy. Recently, treasuries and sovereign bonds of all types are selling off hard in preparation for a tighter Fed in response to the “jawboning.” Equities are suffering less turmoil than bonds for now, but are feeling some pressure.
Global economies are collectively at their slowest points in years. Greece teeters on the edge of another restructuring. That decades long growth engine known as China seems to be struggling with bad debt troubles as its economy shows clear strains. It seems an astounding $20 trillion debt binge over the last decade or so might be catching up there. GDP growth in Europe is near just 1%. We cannot emphasize enough that such an environment is the polar opposite of what would normally move the Fed to tighten.
While we applaud the Fed’s belated acknowledgement of ebullient equity and fixed income markets, it does not change the reality that we are in a predicament where speculative market activity from free money has taken on a manic life of its own that is virtually divorced from the real economy. If that speculation is not stopped now, cleaning up the mess from the excesses will just become harder and harder, though we harbor serious doubts the Fed can muster the courage to do too much in the way of tightening other than talking about it.
Six years of central planning with academics running the world’s largest economies will go down in history as the height of PhD hubris and our generation will be viewed as one that allowed monetary policy to drive the economy to a ridiculous degree. We were effectively told the system was too weak to stomach dealing with writing down bad loans like we did with the Resolution Trust in the early 1990’s and that everyone but the banks must pay a high price for the banks’ mistakes of the last cycle. In 2009 FASB (the Financial Accounting Standards Board) told banks they did not need to mark-to-market anymore and the fantasy began.
Having pushed stocks to the highest median valuation ever by virtually holding a knife to the necks of savers, our dear Fed has transformed the equity market into a call option on investor irrationality. We do not trouble ourselves with determining how long levitation can continue because, as always, we are determined to align ourselves in concert with about one hundred years of market valuation data. We wonder how long investors will be willing to pay twice the normal price for half the normal growth. We also wonder how long central banks can remain relevant after their miracle cure has been exposed as “snake oil.”
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.