• It's Coming...

    MARKET EDGES

    Identify global risks and opportunities with essential macro intel using Hedgeye’s Market Edges.

“So, what should I be doing [investment-wise] now?”

-Barbara Drake (my mom) - passive/unsophisticated investor, 9/13/15

The Mom Test is great.

First of all, everyone has one or, at the least, a reasonable mother-figure proxy. 

Second, our capacity for intentionally misleading Mom to probable personal and/or financial harm is, generally, diminishingly low. 

From an investment management perspective, answering the inquiry has a sneaking ability to distill out the willful blindness and fuzzy narrative framing, laying bare your true inner conviction. 

Take the Mom Test – it’s a refreshing and surprisingly simple exercise in noise reduction and thesis clarity .… unless you’re Robbie Akerlof (go ahead, look it up!)

Back to the Central Planning Grind …..

The FOMC coverage today will be manic and ubiquitous.  Having raised cash for Mom, we’ll stay long of waiting and watching into the open-the-envelope risk, then respond accordingly.

Mom Test - Fed in a box cartoon 09.16.2015

We can, however, provide some context around the current dynamics: 

First, remember the basic goal and mechanics of policy.  The core conceptual underpinning is straightforward but that simplicity tends to get lost in the endless nuance and theoreticals.

  1. Expansionary policy aims to lower the real interest (widening the spread between the real rate and the marginal product of capital) in an attempt to support growth via investment and consumption (interest rate effects) and net exports (currency effects).  *Mom, c’mon, don’t you know the model says you’re supposed to be a rational, intelligent agent who actually knows what the real rate is and makes decisions on what you expect that real rate to be in the future!
  2. Contractionary policy aims to tighten financial conditions in order to quell emergent inflationary pressures. The mechanism is the obverse of expansionary policy with higher rates lowering investment, debt financed consumption and net exports.

Macro markets are a moving target and, at times, market events can serve as a substitute for policy in both directions.  Given that current discussion centers on policy tightening, consider the impact of recent events on financial conditions:  

  1. $USD:  ↑ U.S. Dollar = ↓ Inflation = ↑ Real Rates:  Remember, policy is focused on the real rate (real rate = nominal rate – inflation) with declining inflation driving real rates higher.  Strong Dollar deflation serves as de facto tightening.
  2. Equities:  Equities have benefitted from ZIRP via the Present Value effect:  ↓ Rates = ↓ discount factor = ↑ present value = ↑ equities.  Fundamentally the conclusion is the same: ↓ Rates = ↑ investment/consumption = ↑ Spending = ↑ Profits.  Higher rates, in theory, should have the opposite effect.  Further, with hundreds of billions of market value lost in the last month, valuations and “financial imbalances” have seen a modest correction.
  3. Credit:  Global Turmoil + attempted policy front-running have driven credit and risk spreads higher and pushed rates on the front-end up.   

Translating those tightening financial conditions into rate hike equivalents (i.e. does it equate to a 25 bps hike, 50 bps hike, etc) is tricky but, collectively, conditions have tightened in recent months. 

A few other pre-FOMC considerations:

  • $USD:  As can be seen in the Chart of the Day below, in prior cycles, most of the gains in the dollar have come in anticipation of policy tightening with the currency typically weakening once rates hikes actually commence. #Frontrunning
  • Fed Fund Futures:  As has been well highlighted, Fed Fund futures are only pricing in a 23% chance of a rate hike as of this morning and, given the Feds unprecedented predilection for managing market expectations, an unanticipated rate hike could propagate unwanted volatility.  The hawkish rejoinder is that the fed fund futures market can be thin and the front end of the curve (3M-2Y treasuries) is positioning for a policy shift.
  • Lags:   The outside lag on policy – the Feds view of how long it takes enacted policy to flow through the real economy – is something like 6-18 months. Broadly, this (loosely) argues for pre-emptive policy followed by a lot of wait-and-see.

Janet’s Jinx:  The majority of policy maker consternation centers on the Sisyphean fight for above target inflation.  Yesterday’s CPI data for August which showed headline inflation declining -0.1% MoM only reinforces that reality.

While deflation will, indeed, be transient in the sense that we will lap the energy price collapse and strong dollar/slowing global growth drag on import prices, September will mark the 41st month of sub-2% price growth in the Fed’s preferred Core PCE inflation reading. 

Further, and unfortunately, price growth problems also carry real consequences for the populace.

The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) is the series used for adjusting payments made to Social Security and Supplemental Security Income (SSI) benefits.  The Cost-of-Living Adjustment (COLA) is the government’s attempt at maintaining the purchasing power of social security and SSI payments.   

The COLA adjustment calculation methodology is as follows:

  • Reference Period:  The reference period =  the 3rd quarter of the calendar year (July-Sept)
  • Calculation:  Adjustment Calculation = ave 3Q15/ave 3Q14 -1 (in words:  growth in the average price level in 3Q15 relative to the average price level recorded in 3Q14)
  • Caveats:  If growth in the cost of living is greater than 0.10%, then an adjustment is applied (i.e. social security benefits go up).  If growth is less than 0.10% or negative, there is no adjustment.

With one month left to go in the quarter, 3Q15 is tracking down -0.3%.  In other words, price growth in the CPI-W would have to be +1.2% month-over-month to reach the +0.01% threshold for the quarter and trigger any increase at all. 

Q:  How many times in the last 10 years have we seen a +1.2% MoM increase in the CPI-W?

A:  0 (as in zero)

So, while you’re explaining to Mom how bank assets re-price faster than liabilities (i.e. return on savings will probably stay at 0% even if Janet pulls the normalization trigger) also tell her that the price of living is not rising.  In fact, it’s in outright decline and, with prices falling and Social security payments flat, her real income (i.e. the amount of goods & services she can buy) is actually up +0.30%. 

It’s true, BLS says!

How about the Census Bureau … that paragon of positive macro data flow …. What say you about the household income statement seven years into this expansion?

Yesterday, the Census Bureau released its 2014 report on Income and Poverty in the United States – the annual report that provides the official household income numbers.  The result was not unexpected but it’s still disheartening:

Median household income in the United States in 2014 was $53,657, not statistically different in real terms from the 2013 median income. This is the third consecutive year that the annual change was not statistically significant, following two consecutive annual declines.

LIFE ALPHA:  Mom-ing (to make it a verb) isn’t measured in monthly P&L but in quantum’s of caring and selflessness.  No opening or closing bell, no holidays, no headlines or accolades.

Fortunately, however, and unlike the luck and accidental billionaires of market randomness, “parenting alpha” is largely just a choice and reachable by anyone committed to it.    

Congratulations to Keith and Laura – proud Mom and Dad to a healthy new baby girl and a beautiful growing famille. 

Our immediate-term Global Macro Risk Ranges are now:

SPX 1
Spain’s IBEX 9

VIX 21.67-29.77
Oil (WTI) 43.51-48.95 

Gold 1097-1140

To family and real (non-monetary) wealth,

Christian B. Drake

U.S. Macro Analyst

Mom Test - z z Dollar CoD