Monday, August 22, 2011

Fear of Deflation/Depression do not consider All potential Fed Actions



Bernanke's 2002 Speech

http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm

In 2002, Ben Bernanke told us that a diligent Federal Reserve has all of the tools necessary to stop deflation.  Many have forgotten his speech. They think the Fed is "out of ammunition".

The most familiar stimulus is low interest rates. The Fed has used and continues to use that tool.

The next, the purchase of Treasury Bonds, known as QE2 has been used--it is being maintained, but not expanded.

Low rates and QE are like rocks and slingshots. The Fed has a large arsenal of many other, MUCH MORE POWERFUL tools.

Less familiar, but much more powerful tools remain to be used. I believe the next most powerful is the purchase of private debt securities and foreign debt securities. Finally, in my opinion, the most powerful: purchase of domestic and foreign equities.


No doubt, these tools will be used reluctantly. Given Rick Perry's warnings, monetary stimulus for "political" reasons would not be acceptable. However, the Fed's mission is "price stability" which includes controlling BOTH boom induced inflation and recession induced deflation. This has nothing to do with politics--it has to do with The Fed following their mandate. 

No doubt, all of this is "printing money" and is inflationary. That's the point. To kill deflation or fears of it, the Fed uses tools to create an offsetting or counteracting inflationary force.  The Money Supply is only part of the equation. Increasing the supply of money in an economy where money is "lazy" may only offset the deflation caused by the slow movement (velocity) of money through the economy.  Failure to print more money in such an environment would be the same mistake the Fed made in the 1930's.  They are not likely to make the same mistake this time--no matter what the politics.

Recessions are caused by collapsing asset bubbles or fear driven collapse in demand. They result in the slowing of money velocity. Before the Fed, the only thing you could do is hope that people would get over their fear sooner than later. The Fed's tool box gives it the ability to counter this slowing with a larger supply of money--either preventing the recession or making it shallow and of short duration.

Mr. Bernanke is well aware of the politics of 1937 and 2011--I think those who bet against him doing the right things are making a bad bet.

More analysis of the this subject is available by reading:


This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.







Friday, August 19, 2011

What Next? Is it like 2008 or 2010?




Over the past 60 days, it has been hard to predict the direction of markets for the next day, let alone forecast where markets will be 30 days in the future. Uncertainty and volatility has been extreme. The S&P 500 has fallen 17% from it’s peak in April.

Last year, in 2010, we saw a similar pattern, with uncertainty about European debt and continued high unemployment in the US driving fears of a double dip recession. The S&P 500 fell 17% from it’s peak in April 2010 before rising 33% to the April 2011 peak.

So are we going into a recession or can we expect another 33% gain in the next few months?

In June, I introduced you to the Citigroup Economic Surprise Index. It can be viewed at Bloomberg http://www.bloomberg.com/apps/quote?ticker=CESIUSD:IND#
(under the ticker CESIUSD:IND ) A negative reading of the Economic Surprise Index suggests that economic releases have on balance failed to meet consensus expectations and have “disappointed”. This indicator reached an extreme low on June 3, improving since, but still with a negative reading. The debate about the debt ceiling and brinksmanship of the US government was shocking. The downgrade of the US by S&P was also shocking.  It seems like every talking head and prognosticator has felt the need to go on the record predicting a "possible" recession: 20%, 30%, 50% Chance.  NONE OF THEM KNOW!  (Remember, news media maintains your attention with stories meant to stir your emotion.)

The Federal Reserve QE2 stimulus ended in June. The debt ceiling debate reduced the likelihood of any government fiscal stimulus. In other words, this time, it looks less likely that the US government will, or even can, ride to the rescue of the economy. The really big deal is Europe.

In the US, banks lent too much money to individuals with mortgages. In Europe, banks lent too much money to governments. The individuals had at least some collateral.  Loans to governments are more dangerous--sort of like signature only loans with no collateral.  Too much “tough love” and “austerity” in Europe to reduce this government debt may result in a economic contraction there—a real recession that then might spread all over the world. Concurrent reduction of stimulus by the US Government actually increases the risk.

What many fail to appreciate is that while the end of QE2 ends the increase of Fed stimulus, the Fed is not withdrawing stimulus. Zero Interest Rate Policy (ZIRP) is in place for two more years and the QE balance sheet is being “maintained”. And, while clearly there will be reduction in deficit spending, the US will still be stimulating the economy with deficit spending higher than any time in history except for 2009-2011.  Franklin Roosevelt would never have even dreamed that it was possible for the US Government to throw so much money at the problem. Those that claim the war brought us out of the Great Depression should remember that the US is presently waging two wars.

As most of my clients already know, I study and monitor certain economic data that I call Reasonably Reliable Leading Indicators. While there are some economic indicators pointing to a slower economy, AT THIS TIME, none of what I deem to be Reasonably Reliable Leading Indicators are showing a pending recession. Retail Sales do not show signs of a pending recession. Industrial Production data does not show signs of a pending recession. Corporate Earnings Guidance indicated an expected slowing, but not a pending recession. The Interest Rate Yield Curve is still very steep. Unlike almost every recession in history, corporate bonds are rising or maintaining value as stocks have fallen—a bullish sign that indicates the recent market action is probably just an old fashioned panic and crisis of uncertainty.  When a real recession is likely, people typically sell corporate bonds and stocks at the same time.

Certainly the risk regarding Europe is significant—a lot will depend on the resolve of Germany and how much they are willing to give up in order to bail out the banks that lent too much to Spain, Italy, Greece, and Portugal. Let's hope the ECB stops raising interest rates and learns how to implement intelligent monetary policy.

Again, markets are determined by fundamentals and sentiment. Fundamentals (corporate earnings) are strong. (See graph) We invest in companies. Not only are companies profitable—they have accumulated cash and most have real “staying power” to survive downturns. This is not 2008. It is also probably not 2010 either.

Please remember that sentiment changes rapidly based on current news and information. What we don’t yet know, we don’t know. As I have stated “Life has been uncertain, difficult and dangerous. Uncertainty, difficulty and danger will continue to exist.”

It is very possible that the worst case scenario is already priced in. A 17% drop is a significant correction. (We are also down 28% from the 2007 highs. Some would argue that we are still in a recession--it hasn't ended yet.) History teaches, and indicators tell us that there is a possibility of further declines; But, there is a higher probability that markets will turn back up or at least stabilize. The biggest danger is probably fear itself where fear and resulting collective actions to avoid potential losses actually creates the economic slowdown that people fear and are tryiing to avoid. Emotion is the economy's (and your money's) worst enemy.

In times like these, it is important that any money invested is truly long term—then these short term up/down movements are much less important to you. It is also important to keep the emotions of fear and greed out of your thoughts as these emotions generally lead to bad decisions. Keep your mind on what you believe the companies you own, or want to own will be worth in 2-3 years from now—that is what investors do. Let the foolish speculators spend their energy on what the markets will do in the short term.  Keep in mind: long term investors make money; speculating is a zero sum game.


This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.