The chop of August – as well as price setbacks for many of the year’s leaders to date – has all been pretty normal this summer for the run we have had. This week and next should end the hazy feeling we have been sifting through – capped off of course by the Jackson Hole speeches on Friday. That surely provided plenty of chatter around the media circuit. The fact of the matter is the Fed is no different – they don’t “know” what’s going to happen in the future either.
That did not stop them from coming up with an equally hazy looking chart complete with wide bands of where interest rates were possibly headed. I admit, the words “could not hit the broad side of a barn” slipped into my mind while I was reviewing it and Ms. Yellen’s comments on same. Let’s take a gander:
This chart will get a lot of traffic and be used my many media sources. When you figure out what it means, let me know. From this end – it’s all clear as mud.
In a nutshell, Ms. Yellen joined the chorus of Fed officials who have been saying it is time for another rate hike. She was semi-clear: “Indeed, in light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months.”
Seems to us that is the same email sent around to others as the Fed’s new line. It has been also recently expressed by Fed Vice Chair Stanley Fischer and FRB regional presidents William Dudley (NY), John Williams (SF), Dennis Lockhart (ATL), and Loretta Mester (CLE).
She did not stop there though: In order to make sure that we are all left with no reason at all to be certain about what the Fed will do, she added, “And, as ever, the economic outlook is uncertain, and so monetary policy is not on a preset course.”
Then she really let the listeners in on the big secret in the back room when she posted the chart above. It shows a line tracing the median path for the federal funds rate through the end of 2018 based on the FOMC’s summary of economic projections in June. The labeled Figure 1 also shows a shaded region on either side of the line, which is based on the historical accuracy of private and government forecasters.
The dizzying result is that get this now: there is a 70% probability that the federal funds rate will be between zero and 3-1/4% at the end of next year and between zero and 4-1/2% at the end of 2018! Now that is what we call a trial balloon.
What is she really trying to do? We stand by the comments made for years now: Interest rates are here because of fear. All this chatter, I suspect, has one goal in mind: a dim-witted effort to burn away the fear. The dominos would then fall as such:
Fear fades – long rates rise – leaving curve properly shaped and permitting the Fed to follow the market as it always does – and raise the short-end. If they raise now, we risk seeing an invested yield curve, engineered not by the buyers of bonds but by arbitrary setting of rates by the Fed. That is not policy.
Keep it simple: fear burns away – rates rise. Fear stays in place (as we should be hoping it will with a swoon or two sprinkled in for good luck) – rates stay low, Fed remains on hold – for any number of 7,117 other reasons.
Dr. Ed reminds us that “Yellen did provide some explanation for her vast range for the federal funds rate outlook: “The reason for the wide range is that the economy is frequently buffeted by shocks and thus rarely evolves as predicted. When shocks occur and the economic outlook changes, monetary policy needs to adjust. What we do know, however, is that we want a policy toolkit that will allow us to respond to a wide range of possible conditions.” Fed officials call that “forward guidance.”
In other words, she is sounding more like a Wall Street banker every day, and – it says we are on our own.
Don’t fret though: through all the chatter, we have always been on our own.
Speaking of Growth
GDP revisions got hidden under the intense scrutiny of Jackson Hole chatter. It was revised to a growth rate of 1.1% for Q@ while Q3 at GDPNow is still clocking at around 3.4% with the latest date.
As one might expect the 1.1% brought out the doomsday hunters and they had a field day all their own.
I have a better chart which might hint at why the markets are not listening to all the Black Swan Preachers. It’s another look at the paltry GDP output we are suffering through:
Each quarter, Dr. Ed has a great chart covering all the chatter in one picture. That tiny little ripple where I placed the red dot is the “end of the world” version 987 called the Great Recession. As one can see, it;s pretty hard to see in the overall GDP growth that has been going on since the late 40’s on this chart.
Here is my hunch: The next 50 years will have unspeakable events unfold. Events that will make everything we have already experienced in the last 50 years seem tiny in retrospect. Meanwhile, GDP will create a bigger mountain, on a longer chart, at higher market values.
And on to earnings…
We know we have heard about the earnings recession for 6 quarters now. We have been consistent – it was all about pace of growth for most of the marketplace while the energy sector was taken to the woodshed. Energy masked it all for the masses and the media. The only way to prove that out was to be patient enough to round-trip the worst portions of the energy setbacks.
Our take? Once we did – “growth” would magically return. We are almost there – we had it pegged for end of Q3 numbers marking the return to residual growth from a new base:
The first chart above shows you the latest in the FactSet data with most now reported. Slowly but surely the trough will erase itself. It takes patience, focus and discipline to stay on the course however. That is why so few arrive where they planned – they are too easily swept off course in the always rough seas of an investment lifetime.
The second chart provides the latest snapshot of an overlooked, unheralded part of the economy – chemical activity and sales. It is pretty easy to see that chemical activity tends to be a positive sign about future growth.
The latest data? A new record high. (pray for a swoon ini the markets and a new wave of fear)
While everyone has basically been at the beach or on the road or traveling with family – incomes went up again – also a new high. Don’t forget to review that GDP chart above again – notice the red dot – and our progressively higher record levels.
Sadly, even as we see the highs being set – even allowing for the sloppy internals of the August haze which I understand, admittedly dings numbers in the near-term – the investor crowd is still in a funk.
I will put this chart in below again from Friday to drive home the point – but today, I am adding the 8-week moving average going all the way back to 1990 – with a few markers added to help you visualize:
The top chart is from Friday after a Thursday late release. As noted then, it saw a significant fall in bullish sentiment even as markets chopped around about a percent or so below all time highs. In other words, just a pause gave the masses altitude sickness.
The second chart is a clean version of the 8-week moving average of this same sentiment survey with some of the noise removed. The gray areas are recessions.
The last chart is the duplicate of the second – with dots added by me. Note where we are now in red and where that matches history. Further note that we are merely 3 weeks away from lows in this data which were equal to the lows seen back in the early 90’s when we lost 1500 banks and S&L’s from the commercial real estate setbacks at the time.
The DOW back then? Around 3,100.
The Bottom Line
As long-term investors, we must stay focused through all the haze. It happens every summer.
We must understand chop, churn and setbacks are normal. We must stay disciplined and patient. Without the latter, odds become vast that one ends up in the masses – with frustration and setting the stage for results, over time, which tend to pale in comparison to what the market actually delivers.
Check your emotions at the door. There is no place for them here.