A Fed Game
The confluence between the Fed and economic data will ultimately drive Fed monetary policy. It is important to remember that one must not cherry pick the data nor just look at the headline data. Certainly the Fed is delving into the numbers, because if economic headline data were the end-all be-all for setting monetary policy (GDP growth, unemployment rate, and CPI), the Fed Funds rate would be certainly over 1% and perhaps at 2% by now. Clearly, from the Fed’s lack of action, the headline data is at best questionable. Recently GDP has come into question as being even remotely accurate. Yet, ironically, if you listen to the likes of Fed Atlanta President Lacker (note: not a voting member of the FOMC), you would think that he is ignoring the real economic data to punt a Hawkish tone. I have repeatedly and in detailed clarified the Fed’s position and the forecast monetary policy, all of which point dovish and even the specter of negative interest rate policy (NIRP) is a possibility.
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A Fed Game
First Quarter Review
We started the year with the market under pressure after the first rate hike in December and a Hawkish tone that the Fed was on a streak to raise rates 4 and perhaps as many as 6 times in 2016. Equity positions began to unwind, as nervous investors were heading for the exit door and we saw volatility in short-term rates and currency markets. Was 2016 to be the beginning of unwinding the uber easy Fed monetary policy? Would Fed start their march of raising rates? Unwind their balance sheet? Halt the expansion of money supply? And generally become Hawkish? Many bought into that story after the December rate hike, but gave little credence or even consideration to; real economic data, the Fed governors were appointed Doves, and it was an election year. The December rate hike was a “one and done” event to get Congress, the media, Wall-Street, and everyone off the Fed’s back. The markets have been married to the Fed’s words and expectations, it was time for the Fed to put their money where their mouth was and raise rates.
With economic data trickling in after the start of the year, things were not that rosy and we saw a slew of S&P 500 company’s lower forecasts and given earnings warnings. China’s trade (import/export) dropped considerably. Supply changes were running thin and inventory levels were allowed to deplete, all of which reflected an economic slowdown or perhaps a recession.
Soon talk of a recession in late January was piercing the business news. Even Negative Interest Rate Policy (NIRP) was not just a discussion among fringe economist, but Congress point blanked asked Yellen if it was a consideration, of which the Fed had discussed and even considered it an option. Clearly there was concern about an economic slowdown.
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The Fed’s Hawkish tone and expectations for 2016 took a 180 degree turn and with the wave of the hand again became Dovish. The markets rejoiced that the Fed, in the face of a possible economic slowdown, was back to their easy money stance and that no rate hikes were to come in the immediate future. The market rebounded in the second half of the 1st quarter as low interest rates and easy Fed policy was to remain in place. As quickly as the market dropped on concerns of a Hawkish Fed, it reversed course just as quickly as the Fed turned Dovish.
Shaping up for the Second Quarter
As the market was back to its recent highs and took a mulligan for the first quarter, with a sigh of relief, all eyes quickly turned back to economic data and now earnings.
Earnings for the most part, and not surprisingly as companies had warned, have come in weaker than expected. The glowing concern was not the bottom line profits, but rather the weak top line revenues and sales. Across the board topline sales and revenue have been weak and in many cases contracting. Clearly there is a global growth slowdown, again not surprising after China, Japan, and Europe all reported weaker; trade, GDP growth, and employment. In unison Japan and Europe took rates into Negative territory – NIRP is no longer the talk of fringe economist, but real – no longer to be ignored. The massive stimulative efforts in Japan and the EU are not spurring the economic growth government theoretical Keynesian economists expected. When you take rates to negative and shovel unbelievable amounts of stimulus into an economy and it will not grow – something is amiss and where do you go from there?
Again, much like in 2010-2012 corporate policies have turned to the ever powerful “share buy backs”. With rates this low and top-line revenue contractions, the only way to boost Earnings Per Share (EPS) is to reduce the float. Additionally we are seeing cost cutting and an increase in lay-offs, Challenger Report (future lay-off expectations) on the rise. Businesses are far better at seeing economic cycles than the Fed, as they have lived through them, have real experience with revenue growth/contraction, and have to maintain profit margins. The business world is taking action.
S&P Earnings were estimated at a 9.5% growth rate, while earnings have not concluded for the 1st quarter, data so far reflects just above 7% growth. Analyst forecast the decline to continue into the 2nd quarter as well.
Jobs and Unemployment
Interestingly and probably far more accurate, the TrimTab’s report – which measures the labor market based on real-time withholding taxes – has been showing contractions. Additionally, ADP report (measuring private sector payrolls) as well has been weaker. For anyone that wishes to measure economic data, it would be reasonable and logical to assume that one would use REAL data (ie. withholding tax, payrolls, etc). The government on the other hand uses surveys for the most part, which literally polls about 60,000 people in various parts of the United States, adjusts the results based on all kinds of machinations, tosses in a seasonal adjustment and thus spits out an extrapolation with a rather large margin of error that represents the 350 million people of this nation, Oh – I forgot to mention seasonable adjustments that can be 3 standard deviations. That is all well and good if this was the pre-computer age prior to the 1970s, but if private companies (ADP, TrimTab’s, and other) can harness the amazing technology we are surrounded with to give us REAL data – you would think the government could as well. Government is still operating in the 1970s and I thought it invented the internet – geez!
Of course I have been skeptical of the GDP and CPI headline data, simply because of their methodology. The Labor Report is no different. The U3 unemployment (Official Unemployment) has seen radical changes over the last couple of decades, not to mention its old school survey methodology – all of which is questionably unsound in today’s technology age. Even the U6 has issues with the drop-off of the “discourage workers” after 12 months, which means the model has an artificial deflation rate.
Yet despite my valid criticisms of methodology and whether any bias is inherent or intended, it is the data the Fed supposedly relies on, politicians showcase, and the markets wait with bated breath. As previously mentioned the GDP numbers have recently come under scrutiny by even Keynesian economist and now the Labor Report is facing more skepticism as well. While the Fed may quote the headline data, they certainly are not relying on it to set monetary policy. So it becomes nothing more than window dressing for politicians and the gulf between headline data and the real economy continues to widen.
Ironically even though the Fed doesn’t use the big three headline economic data to set monetary policy, they do use it for justification for not taking action. The Fed’s “data dependent” stance to set policy is rather absurd. If we are actually to believe that unemployment has fallen to 5% and we have had this surge in job creation (real full-time jobs that is), then how come rates remain at, or close to zero, how come the Fed continues to inflate the money supply, how come the Fed continues to buy bonds and mortgage back securities, how come the Fed doesn’t reduce their balance sheet, how come the Fed remains uber Dovish despite their rhetoric? Clearly, the headline data is reporting one thing and what is happening on the ground is another.
Change in the FOMC statement
There is one thing that has certainly changed in the Fed’s FOMC statements. Initially, as the global markets and economies had been improving over the years, the Fed’s justification for NOT raising rates and remaining Dovish, was concerns about the labor market. Certainly they noted it was improving – citing economic headline data, but that was always concluded with text like: “labor market indicators show underutilization of labor resources”. Clearly they were concerned about the participation rate (which Yellen noted in Congressional testimony), job-type creation (more part-time than full-time), and weak wage growth. All of which is masked in citing only the headline unemployment rate.
Today, we no longer find the concern in the “underutilization of labor resources”, because blame can be shifted elsewhere. For the first time we begin to see concerns about the global economic slowdown. March’s FOMC statement includes the following: “global economic and financial developments continue to pose risks.” While true, it also comes with some convenience as the Fed can now shift the justification from their own concerns about weak structural labor conditions to global economic risks. As one economist correctly pointed out, the Fed’s responsibility is to our economy and if they believe domestic economic conditions and labor markets have improved – as they site – they should raise rates, regardless of what’s going on in the likes of Japan and other places. He concluded, is not the Fed’s dual mandate employment and inflation? When did it become global economic trends?
Courtesy of wikipedia
While I believe his observation is certainly true, those debates are focused on semantics and Fed wordsmithing, rather than the reality – which the Fed had been previously eluding to – issues with the “structural labor resources”. Again, it gets back to the difference between headline data reporting and economic reality. We are living in a Fed stimulate economy in which the private sector has become dependent on and there remains rather significant structural problems in the labor market.
The Labor Report just last week reported something more in line with both TrimTabs and ADP, with an increase of 160,000 jobs. That came in below expectations of 202,000, which lowered expectations of a rate hike in June. A rate hike that really was never going to come, regardless of expectations. The data behind the headline number showed a drop in the participation rate, an increase of those dropping out of the labor force (over 300,000), and a drop in the employment-to-population ratio to 59.7%. There were some silver linings in the data, but nothing overwhelming to shift the general trend of a stagnant labor market. As the Fed puts it, “underutilization of labor resources”.
The market has rebounded from the losses of the first quarter and pushed up against the recent highs again. Not on fundamental earnings data – which are weak, not on economic data as labor markets look weaker than expected, not on trade which is also weaker, not on global economic growth which is weaker, but solely on the fact that all this weakness means a more dovish Fed monetary policy and rates that will remain very low in the foreseeable future.
The question at hand, is whether the market can rally further from here. Can it push higher despite the weak data, solely based on the Fed remaining status quo and keeping rates low? Or does the Fed have to become more accommodative, perhaps following Europe and Japan with a Negative Interest Rate Policy (NIRP) and/or some more stimulus – be it another QE or something similar?
The consensus among company’s forward guidance and analyst that follow the companies is for lower top line revenue and weaker growth in the next quarter and over-all for the whole year. That in turn has lowered expectations for future rate hikes.
Global growth, (based on shipping, export/import, central bank policies, and GDP), is also weaker and reflecting a weaker trend. Which only furthers justification for a more Dovish Fed, something they have already quoted as a concern.
I am certain the Fed as well as any government interventionism will additionally work to keep the market aloft the best they can through the election cycle. Not to mention that the election cycle has turned into a circus on both sides; Bernie Sanders continues to gain strength and regardless if he is able to capture the nomination and will head into the DNC convention with some demands to the platform. Hillary’s popularity is as low as ever and she is not winning over independents or the young voters, which flock to Bernie. The data shows Bernie as a stronger candidate against Trump. On the GOP side, while Trump has seemingly locked up the GOP nomination, the old school establishment continues to rail against him and no one knows what to expect at that convention. Hillary is the presumptive next president and with the Fed governors all appointed by one sitting President (unprecedented I might add), they will certainly try to maintain, if only optically, a strong economy while pursuing easy monetary policy.
Technically speaking, the market seems to be forming a “head and shoulders” pattern, for what that’s worth. Yet looking into the liquidity and order flow, it is getting lighter in here and that means unless we see some strong buy side volume and lighter sell side liquidity, it will be hard pressed to rally higher – above resistance. Already there is talk among leading traders and financiers to lighten up on equity market positions as we face both a volatile uncertain election cycle coupled with weaker economic data.
So while I don’t expect a crash or large correction in the market, if the Fed and interventionist policies have anything to say about it, I do suspect a weaker market with 5% corrections and possibly to even 10%. The upside is limited, there is room certainly, but I am not sure anyone wants to extend margin, coupled with volatility exposure. Of course the Fed could pull the NIRP trigger and all bets are off and this market could rocket higher on that news, at least in the short-term. However, that might be a gift given after the election – if Hillary or Bernie are the President.
Courtesy of wikipedia
Courtesy of wikipedia
Republican: Donald Trump
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Libertarian: Gary Johnson
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Support & Resistance
INDU 17,600 – 18,000
We are in a short-term bounce which seems like a head-n-shoulders position. The buy-side volume is a little light at the moment, but we don’t see any aggressive selling either. I would expect some resistance as we get into 18,000 and on a pullback short-term support at 17,600.
NDX 4300 – 4500
The tech heavy index has been bashed and bruised. Apple is starting to fall out of favor with no innovation in their product lines, while unicorn company’s multi-billion dollar valuations are being re-evaluated. There are some hostile legal battles in this space as well, between Google and Oracle, as well as the Yahoo court case – both of which could cause damage to the tech sector. I think a move to 4500 can certainly happen, with resistance kicking in at the 4450 level. The down side is 4300 with some general support.
SPX 2040 – 2100
The S&P 500 earnings have come in even weaker than originally predicted, which has sent the index down from 2100 to 2040. However – economic and labor concerns have lifted the specter of a Fed rate hike anytime soon and that has given investors some hope that the rally can continue to back of ability to borrow cheap money. I see resistance start kicking in at 2080, but with the possibility to spike to 2100. Support will be at 2040 on any pull back.
RUT 1100 – 1140
What says the general market order flow, not driven by single overweight stocks that can mask narrow index valuations? The Russell has proven to be a strong show of order flow, rebounding for the low and pushing to December 2015 highs. Recently it has come off and pulled back to 1100 and the last couple of days have rebounded. However, I suspect any bounce from here into the 1140 level will be met with resistance, as general fundamental data and economic data have weakened. It is certainly true that the Fed has stepped back from their Hawkish stance, but I not sure that will be enough.
Dollar at Play!
What is at play is a weakening dollar. The dollar index has weaken and that has helped buoy oil and commodity prices. Could a weaker dollar help keep the market aloft amidst weaker global market economic data? It certainly could, relatively speaking. A more dovish Fed or perhaps a NIRP stance by the Fed, could certainly weaken the dollar further, send commodity prices higher, and fuel a general market rally. However the Fed knows that is going all in and the complete opposite direction of any Hawkish position they equivocate, will bring forth unwanted concern and criticism of an asset bubble they have already exacerbated.