CONCLUSION: We shorted $GLD and bought $UUP in our Virtual Portfolio yesterday afternoon based largely on our view that Chairman Bernanke will not announce further easing at Jackson Hole.
As Shakespeare once wrote, expectations are the root of all heartache. Next week, expectations heading into Jackson Hole by equity investors are heightened to say the least. As incremental economic growth data continues to slow, there is really little reason left to justify the recent ramp in U.S. equity markets other than the perceived panacea of a potential monetary easing announcement in Jackson Hole.
To be fair, the FOMC minutes from yesterday certainly did leave the door open:
“A number of them indicated that additional accommodation could help foster a more rapid improvement in labor market conditions in an environment in which price pressures were likely to be subdued. Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.”
Nonetheless, we still believe that the next two monetary policy catalysts that are on the horizon that investors are hyper focused on (i.e. the AUG 31-1 annual central banker bonanza in Jackson Hole, WY and the SEP 13 FOMC Announcement) are likely to disappoint. While the manic media is likely to do its best to perpetuate expectations of additional “accommodation” among investors, we expect little to no change in US monetary policy out of both events. Needless to say, our outlook for US monetary policy over the TRADE and TREND durations remains counter to consensus expectations.
Looking back to Jackson Hole 2010 when the Fed overtly signaled QE2, we can safely conclude that the conditions are not in place for the Fed to pull the trigger at either of these upcoming events. Moreover, the OCT 24 FOMC meeting is far too close the election for the Fed to act, in our opinion. The caveat here is that the FOMC, a presumed-to-be-independent board of unelected bureaucrats, can do whatever they please.
That said, however, we anticipate that rising political scrutiny about the stagflationary impact of their recent policies will force them to become more, not less, prudent with regards to their decision making. As we demonstrated yesterday in our note titled, “FIRE IN THE [JACKSON] HOLE: BATTLE LINES ARE BEING DRAWN IN THE US MONETARY POLICY ARENA”, quantitative easing amounts to a highly regressive tax on the poor, begging the key political question: why is Obama such an avid Bernanke supporter?
Regarding the aforementioned conditions, we parse the Fed’s mandate into its three pillars to show just how aggressive and politically compromised the Fed would look in the event it introduces yet another LSAP over the immediate-term. For reference, Obama’s reelection odds correlate tightly with the SPX per our proprietary Hedgeye Election Indicator, as well as those provided by sources such as Intrade.
MANDATE #1: Inflate the Stock Market
The S&P 500 had completely broken down to the mid-to-low 1,000s ahead of Jackson Hole ’10. At ~1,400 on the SPX, the argument that the stock market requires additional stimulus loses a great deal of credibility.
MANDATE #2: Full Employment
Heading into Jackson Hole, we had seen two consecutive months of negative MoM Nonfarm Payroll growth and a total of four consecutive declines by SEP ’10. No such negative trend exists currently.
MANDATE #3: Price Stability
Core CPI was threatening the economy with the specter of deflation, slowing all the way to +0.9% YoY in JUL ’10 and then down to +0.6% YoY by OCT ’10. We’re at +2.1% YoY per the latest data point (JUL) – in line with the Fed’s +2% target. Additionally, the Fed’s own 5yr forward breakeven inflation rate is at 2.57% currently – well above the low of 2.17% we saw on AUG 24th, 2010.
Our quantitative levels on Gold are included in the chart below. Specifically regarding the etf GLD, we see heightening risk of forced sales over the intermediate term as John Paulson & Co., the etf’s largest owner at 5.14% of shares outstanding, may be forced to get incrementally liquid following the news that Citi Private Bank will redeem $500 million from Paulson’s flagship Advantage funds.
Daryl G. Jones
Director of Research