I just returned from a speaking engagement in Tennessee where I decided to do a “low tech” presentation on the current state of the financial markets. Low tech means no PowerPoint slides… just good old-fashioned notes on a yellow pad.
I thought I would share what I wrote down on the way to Nashville:
Inflection Point: (N) – Mathematics – A point on a curve at which the curvature changes from convex to concave or vice versa.
In describing our current thinking, I have to resort to an investment writing cliché where the financial markets are described as being “at an inflection point.” While the mathematical definition for an inflection point is presented above, in the business of investing inflection points occur where there is a change in the long-term trend or momentum of the financial markets, economy, or price of an individual security. Inflection points are critically important because if you recognize one and if you understand the significance of the change, then you can make a lot of money.
Just two days ago the 4th quarter GDP came out as a negative number, which was much worse than expected. In fact, not one of 83 analysts had anticipated a negative number, meaning they were all too bullish on the 4th quarter growth number. But yesterday the Chicago Purchasing manager’s index, a growth barometer, was way above expectations for growth, and not one of 48 analyst estimates was in the ballpark, meaning they were all too bearish on growth.
In my last column, I described a bearish scenario where the markets come to the realization that the monetary authorities are out of bullets. This was simply an exercise in critical thinking and doesn’t actually line up with our current forecast, and I did promise I would come back with a bullish scenario.
One of my favorite scenes in the Pixar movie Finding Nemo comes at the end. The fish had managed to outwit the Dentist (who was holding them captive in a tank) by dirtying the water enough to force a water change. In order to do that, the Dentist had to bag the fish and leave them outside the tank, at which point they jumped out the window and into the harbor below. Unfortunately, they hadn’t considered how they were going to get out of the plastic bags. The movie ends with one of the fish asking, “Now what?”
The Federal Reserve spoke yesterday, and not surprisingly decided to buy more treasury bonds to keep expanding the balance sheet. It might have been a bit surprising that they have now also explicitly targeted an improvement in the unemployment rate (6.5%) and stated a tolerable inflation band (2.5%) for investors to use as guides for when the Fed might engage in policy withdrawal. The market went up for a few hours, and then drifted back to earth and closed unchanged on the day; Fed decisions can’t force politicians to trade in political theatre and come up with a deal before the 11th hour.
Everybody knows that the dice are loaded.
Everybody rolls with their fingers crossed.
Everybody knows that the war is over.
Everybody knows the good guys lost.
Everybody knows the fight was fixed.
The poor stay poor, the rich get rich.
That’s how it goes,
Everybody knows.
Leonard Cohen, “Everybody Knows”
Right now we sit in an unusual place in financial history: World fundamentals are taking a back seat to policy makers who are defending the current system with new monetary tools. As market analysts, we’ve watched the perpetual bull and bear debate grow as divisive as ever, and while both camps have impressive arguments, neither camp has enough history to make their case.
Bearish investors look at the chart below and immediately notice that Fed intervention in the form of QE1 and QE2 (quantitative easing program 1 and 2, or perhaps more accurately, money printing programs 1 and 2) occurred after substantial market declines. QE1 is announced after the Lehman Brothers collapse in 2008 and QE2 is hinted at when Bernanke addressed the Jackson Hole conference in the summer of 2010 (after we learned of the Greek debt problems). Given that last week’s news regarding fourth quarter GDP was somewhat disappointing, bears would warn risk takers not to count on the Fed to announce a new QE3 program that would support the equity markets until after the next major stock market correction, or bear market. In addition, the magnitude of the impact of the Fed announcements on the market seems to be diminishing. The market move during QE2 was less than QE1, and the subsequent policy shifts have had less impact than QE2.
