“It was too easy to brush aside bounded rationality as a true but unimportant concept.”
“Bounded Rationality” is the term coined by one of the great non-linear minds in American history, Herbert Simon. He wrote about it “well before Kahneman and Tversky came along… saying that people lack the cognitive ability to solve complex problems.”
Oh don’t get your under-pants in a bunch this morning. I’m not suggesting you can’t solve complex problems. That’s your job. When Thaler says “people” aren’t that smart, he meant The People – as in the bros on Main Street don’t do efficient market hypothesis.
As Richard Thaler goes on to remind us in Misbehaving (The Making of Behavioral Economics), “economists are fine with the idea that their models are imprecise and that predictions contain error” (pg 23). But what happens when their mistakes affect The People?
Back to the Global Macro Grind…
Will the Fed make another monetary policy mistake and raise rates into a classic #LateCycle slow-down? Janet’s latest answer to that question is “probably.” And I spent all of yesterday debating institutional investors in the Midwest on timing another mistake.
Just to set the table here for what may be true, but not yet important:
- Fed goes HAWKISH and tightens into a slow-down in December
- Fed then goes DOVISH and devalues the DOLLAR in March/April
- Fed then goes HAWKISH in May and the DOLLAR rallies for 3 straight weeks
Everyone agree with that? Ok. Now what?
- What if the US Jobs report for May (tomorrow) is another rate of change slow-down?
- What if the US Jobs report for May “beats” a headline expectation that implies continued slowing?
- What if both the May and June jobs reports are #LateCycle Employment slowing reports?
You know that Janet “probably” raising rates in July has 2 jobs reports pending in front of it, right? Oh, right – “but if you’re right on #TheCycle, Keith… and labor continues to slow, then she’ll just go dovish again and not hike.”
Do you agree with that? If you do, in the span of 6 months, the Federal Reserve will have gone from:
- HAWKISH to
- DOVISH to
- HAWKISH … and back to
As one Portfolio Manager (who has been very long of Utilities, which are now +13.6% YTD) said to me after this exchange yesterday, “lol – good luck landing on all four of those dots.”
And doesn’t that summarize the guessing game that we are in? Not only do we have to strive for excellence in our forecasting of the trending rates of change in growth and inflation, but we have to solve for what inaccurate forecasters are going to do in the meantime!
As a reminder, on Janet Yellen’s publicly stated preferred LABOR MARKET INDICATOR (her “Change in Labor Market Conditions Index”), including the April reading, US Employment has slowed to NEGATIVE for 4 STRAIGHT MONTHS.
In addition to the labor cycle, back to what is also true and important – i.e. the profit cycle:
- 493 of 500 S&P 500 companies have reported Q1 2016
- Aggregate SALES were -2.2% y/y and EPS -8.4% y/y
- 6 of 10 SECTORS were negative y/y EPS, including Financials -14.2% y/y
Never mind that the aggregate numbers are non-GAAP. We’re having a tough enough time trying to understand why both US GDP and Personal Consumption are being overstated by “Deflators” that are being understated by 40-60% vs. the Fed’s own calculation of inflation. Even on a non-GAAP to non-GAAP (apples to apples) basis, the USA is in a profit #Recession.
How about the credit cycle? Oh right – another true but unimportant factor for weekly chart-chasers to consider until it matters again… What happened to High Yield Spreads last time (i.e. the only time in modern history) that the Fed tightened into a slow-down?
Economic Cycle => Profit Cycle => Credit Cycle?
Instead of flailing like a dove pretending to be a hawk, maybe Janet should consider the causal factor in perpetuating the #Deflation risk across asset classes (Rate Hike => Dollar Up) that she completely underestimated in December. It’s a true and important concept.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.80-1.90%
Oil (WTI) 46.87-49.99
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer