This note was originally published at 8am on August 31, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody”.
-James Carville
Markets are intimidating and they don’t wait for anyone. Nor do they owe anyone a return, as Keith likes to say.
When James Carville made the above quote, he was referencing the melt up in 10-year yields in the early stages of Bill Clinton’s first term as president. Bond investors, at the time, were concerned about federal spending. Subsequent efforts by the Clinton administration to control the deficit, which helped to strengthen the dollar, led to the bond investors’ fears being assuaged: yields trended lower and stocks surged, for the most part, during the remainder of Clinton’s stint as Commander in Chief.
Markets are at least as intimidating today as they were in the early 1990’s, when real-time prices forced the government to sober up. In the age of social media, where information is more accessible than ever, anyone can be a part of the debate. In general, I would argue, this is good for the country as it allows a broader range of views to be heard by a broader range of people. Popular consensus, in a way, is changing on a tick like real-time market prices, thanks to the democratization of information. For the political players in Washington, this is intimidating.
Although real-time communication is becoming the norm, certain members of the financial community will likely resist that move and, like others before them across industries that have resisted positive change, they will be left behind. The Federal Reserve’s inability to prop up equity prices in perpetuity has set alarm bells ringing in Washington this year as Hedgeye’s call for Jobless Stagflation, induced by ineffective Keynesian policies, has manifested itself. For now, it appears that policy-makers are sticking to their guns, but to the extent that real-time prices and economic data continue to weigh on sentiment, the time for the incumbent players to act could be limited.
Despite Charles Evans’ best attempts, yesterday on CNBC he ignored the fact that markets discount future events (like the cessation of QE), and equity markets have declined globally on expectations that the global economy is slowing. In the U.S., the primary source of pessimism (and ultimately the primary potential for renewed growth) is the consumer. Despite trillions of dollars of government spending, consumer’s expectations for an improved economy have not changed significantly over the past three years.
Yesterday’s bomb of a consumer confidence number from the Conference Board came as no surprise to anyone. In an effort to look for a positive in what was a decidedly negative report, the stat that stood out the most to me was that more than half of consumers expect the stock market to be lower in a year, the first time that has been true since March 2009. However, this is not March 2009, this is 2011.
In my view, there are four primary ailments that need to be addressed for a consumer recovery to take place.
(1) The political machine in Washington, D.C. is broken.
This one is obvious. The debt and deficit debate put the spot light on everything that is wrong with Washington politics. Dylan Ratigan recently expressed the frustration many Americans are feeling during his rant on MSNBC during which he accused legislators of being “bought”. Howard Schultz, the CEO of Starbucks, seemingly agrees as he is encouraging business leaders to just say no and stop funding the madness via political donations. Ratigan, for his part, has shown no mercy for either side of the aisle. During his now famous rant, Ratigan accused Democrats of “kicking the can down the road until 2017” and “screwing” future generations by not offering long-term solutions for extractions from the economy. Turning to Republicans, he stated that they simply want to “burn the place down” and pursue a negative agenda.
(2) Perpetually low rates is killing confidence
Easy money creates bubbles which have a severe impact on consumer confidence given that consumers are usually the last to the party.
(3) The Keynesian policies of the FED is slowing GDP growth
Quantitative Easing is inflationary! While Mr. Evans was on CNBC, refusing to admit that QE2 was inflationary, it was obvious that he was ignoring inconvenient facts while admitting only those that suited his stance. Markets are discounting mechanisms and hinge on expectations; the longer-term view of QE2 is highly conclusive; the result was a weakened dollar and a 29% surge in the CRB index over the past twelve months. Stagflation is back and it is scaring the public.
(4) The Government inflates the data to build up expectations only to be shot down with constant downward revisions
The most glaring example of this is seen in the BEA's use of "deflators." The BEA is telling us that they believe that inflation over the prior two quarters has been running at annualized rates of 2.5% and 2.7% respectively and the annualized inflation rate for the prior four quarters was just barely over 2%. You tell me!! Is it really plausible that over the last 12 months we saw net inflation of barely over 2%?
On Monday, the government reported that personal spending increased 0.8% in July. This was a 100 basis point improvement from the month prior. Consumption is accelerating despite numerous headwinds. I have become very cynical about government data and it does require a leap of faith to assume that the government has accurately captured what is happening in the real economy.
Despite a significant downturn in equity prices during August, the S&P 500 is now 10% “off the lows” into month-end. The market faces a difficult macro calendar in September including another attempt from the Obama administration to jump-start the economy. One thing Obama knows is that markets are ready-and-able to tell him if he is not doing the right thing. Coming up to the election, the incumbent president needs a win, but solutions to the problem of Jobless Stagflation and ideological dogma in Washington, D.C. are what the market of popular consensus is demanding.
Function in disaster; finish in style,
Howard Penney
