A few weeks ago a client asked me if I thought the Fed would cut rates. I said I thought yes but I questioned what the consequences would be.So it seems inevitable that we get a cut of 25 beeps in the Fed Funds rate while the market seems less certain about what will happen with the now relevant discount rate.
Although not an original thought I can't figure how the market can take any Fed outcome positively.
With a 25 basis point cut the Fed might be perceived as being behind the curve. With a 50 basis point cut they raise the question of just how bad is it. Of course as I say no positive reaction seems possible the market could race higher with a resolution to one of the big questions looming out there.
Another reason to think the market cannot rally is the answer we get today will of course raise many new questions, that is just how it works, nothing ever gets resolved.
More important than trying to guess the immediate reaction might be to look a little further down the road at what might be coming. Despite some well reasoned (or not) commentary to the contrary I don't think the dollar can rally off of an easing cycle, but I will concede that anything is possible in the first day or two.
All of what has happened thus far is about some sort of problem in the US that reveals a weakness of some sort. From a common sense stand point the stronger dollar case does not stand up for me.
Owning foreign anything for the last few years has created a nice tailwind which I think is likely to persist.
The longer term theme, even if how long is unclear, is the cutting will eventually lead to a normal yield curve which will change how a lot of bond portfolios are deployed, at least the ones I manage.
19 comments:
Dropping $$$$ out of a helicopter, is just what our country does best. The Cons spend billions on other countries yet no one seems to care. The Dems spend tons of money on Americans and they can hammered because it will raise taxes. Maybe the Dems need a printing press like the Cons.
Dollar will continue to weaken as China and European nations raise rates. There is a perfect storm brewing for a huge fall in the US Markets.
If the FOMC cuts, it will spur economic growth at the margin. This new activity will absorb the excess liquidity that has resulted in the weaker dollar. Once the dollar strengthens against gold, it will also strengthen against other fiat currencies.
http://tinyurl.com/ys5bav
I strongly recommend people take another look at the lower chart in figure 1 on page 38 “Ratio of Household Sector Debt to Personal Income”.
Last time I pointed this out Roger was blinded by his stay diversified and invested fixation. When I pointed out US households indebtedness went from less than 0.6 of income to 1.2 times income from 1980 to 2006, Roger said we were more sophisticated now and I guess can handle more household debt now. I interpret this as saying our excessive levels of household debt are DIFFERENT this time.
Personally I strongly disagree with Roger if you have not figured that out yet. I hate to pick on Roger so much because I think many readers of this blog are just as wrong in realizing the consequences to come as well. (so now that I have upset pretty much everybody…)
I am not trying to make this point to upset people as much as I am to hate to see you all loose your shirt. What to do? Depends on if the Fed wants to inflate there way out of this or not. These household debt levels have got to come down. If they do not do it now it will be worse in the future.
The Fed should have accepted a mild recession after the excessive debt levels caused the Nasdaq bubble, but easy Al decided the Fed should avoid the recession and “fix” it by making the housing bubble. Another fix like that and we could be in real trouble. A mild recession and writing off of nonperforming loans is better than continuously increasing a debt bubble.
Do not get me wrong the world is not going to come to an end, but creating more household debt by excessively lowering interest rates could lead to excessive inflation which will kill the stock market and boomer retirements in the long run.
Mild recessions are not fun but letting household debt levels continuously increase until household income can not support the household debt levels is a recipe for total disaster. The Fed needs to accept the economic cycle and let a mild recession and the writing off of nonperforming loans occur.
They have actually let things go to far in my opinion and may need to accept a series of recessions to get things back to normal. I’m not so sure you can accept all the write offs of nonperforming loans at once as at it could lead to deflation and depression and nobody wants that. The other alternative is to get rid of the excessive household debt by allowing excessive inflation reduce the debt and then the gold bugs will end up being correct like it or not (personally I do not like it when the gold bugs are correct but I will join them if I have too).
Which course will the Fed choose? I do not know, but neither of them looks very good for equities IMO.
Why is it that folks who think the sky is falling and/or call out the host lack the simple confidence to put thier name on their statements.
I would actually like to know who these anons are, since they seem to know so much that the millions of market participants are missing.
Once they are proven right, I might like to hire them, but alas...
Roger - Re: "Foreign anything"
John Maudlin's "Outside the Box' has a scary write-up on Northern Rock's problems.
I think I will go over to Marc Faber's site to get cheered up.
OG
REW, you articulate the dollar bull case and it sounds well reasoned but it is difficult for me to put it together.
Anon 7:34 I believe you and I have different goals. If you turn out to be correct the market will dictate the action I need to take. I don't need to be correct I just need to be faithful to my defensive strategy.
If you are the same person who has been writing this thread for a while I read a desire on your part to be correct. I would rather plan out what I would do in varying situations than analyze the hell out of one outcome.
Different priorities.
funny stuff OG.
I apologize if you took foreign anything to imply no need to do any diligence.
http://tinyurl.com/yom3ft
humor
"...I read a desire on your part to be correct."
YES
I think understanding what type of environment we are in is important. I hope we will know more soon.
I do think your blog is a lot better than most. What you do well is give clear, objective, and unbiased, information on things you understand (which is a lot). The main reason I read your blog.
but I obviously have a problem with staying invested in light of obvious problems why you do not. You stick to a plan that probably works well most of the time.
I see the Fed between a rock and a hard spot. So I see no reason to hold equities until losses become unacceptably high. Unfortunately I still do not know which way the Fed will go, but I think a clear understanding of the underlying issues is very helpful.
Anon 7:34 Given your prescient read of market conditions, would you mind giving us your portfolio
choices? Having tried market timing services,
(still use Brinker), and a rogue's gallery of investment
advisors, I like Roger's general defensive strategy to
use double reverse ETF's to balance the roller coaster ride as opposed to trying to guess the market direction on any given day. Roger uses what appears to be a sector rotation strategy which is long the market and uses defensive parachutes when it gets too windy. Keep up the good work, Roger.
My read: Not as bad as expected results from LEH seemingly more important than already priced Fed move today. If GS and Barclays turns out to be also not as bad as expected, the market tone should much improved. So LEH increases the chances of a happy near term.
analyst Richard Bove said that LEH beat was due to a lower tax rate. For now it does not seem to matter.
"Anon 7:34 Given your prescient read of market conditions, would you mind giving us your portfolio
choices?"
First I would like to point out that investment decision prior to clear Fed direction IMO is a bet at this point.
I also subscribe to Brinker because he has a good track record and does not time the market frequently. I hate frequent timing.
I am mostly in cash since early July, but I have added a little Double short S&P 500 last week based on my bearish outlook. If the Fed moves 50 bps I am sure I will loose money due to a short term rally. But if the Fed chooses to flood liquidity I think there will be even larger problems to worry about. I am hoping for a more reasoned and rational approach of 25 bps from the Fed.
"Investors should brace themselves for a prolonged period of market turmoil, Henry Paulson, the US Treasury Secretary, said yesterday as he held emergency meetings with the Chancellor and the French Finance Minister."
http://tinyurl.com/2fxejc
Anon 7:34
I agree with you that this credit and subprime mess will most likely turn out to be an economic event and not just a financial event as some Wall Street pundits suppose.
http://tinyurl.com/2waaw8
And foreign markets most likely will not offer much of a safe haven either.
http://tinyurl.com/33cc6q
The housing market is the biggest industry in the country due to it's direct and indirect connection to finance, builders, contractors, commodities such as lumber, chemicals (carpet, paint)etc. Folks in these and other related areas will soon have a whole lot less money to spend. I believe that a recession is inevitable.
I am in the process of transferring my 401K and will keep it in cash until this thing pans out.
That being said, there is nothing wrong with Roger's and other folks strategy of staying the course with their portfolios. Why? Because no one can effectively time the market. I too like Roger's strategy of adding double shorts to smooth out the market. There are also tax and trading costs associated with trading in and out of the market. There is a reason why Dimensional Funds is the best fund company out there. They don't trade much and they buy and hold a well diversified portfolio.
I used to be in the other camp of timing the market and following the trends as well until I read Ron Ross's "The Unbeatable Market". (not to mention seeing my portfolio suffer with those bad choices)
And Russ...if I'm right how much do you pay? My name's Jack BTW and I could use a side job. :-)
The whisper and the fear about LEH were a lot worse. I'm not trying to make bullish calls on these prime brokers - just happy when they look like they aren't going to take down the market because of being too strapped to carry out their important business lines. In other words, it's not their upside that matters, it the lack of them causing downside for the rest of the market.
well I was clearly wrong about the Fed and glad I had limited my double short to just a little (less pain).
I really was not expecting excess liquidity to be the Feds first choice, but I think I need to reconsider.
So glad....now my dollar bill is worth even less.
I'm sure Bernanke and the fed gov boys have their money hidden somewhere in Switzerland.
Something just does not add up here. I know the old addage is "follow the trend", but my spidey senses tell me otherwise. I'll stay cash for a while.
1:12 anon:
Well, put your money in Switzerland and stop crying about it.
The trend is your friend.
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