Weighing the Week Ahead: Fixation on the Fed

The “Week Ahead” series is a relatively new concept for me.  I have only been doing it for a few weeks.  It is “thinking out loud” since it is work I always did anyway.  I am open to suggestions.

There are many good services that do a complete list of every event for the upcoming week, so that is not my mission.  Instead, I try to single out what will be most important and help investors think about it.  My theme for the week is what will be the big story for print media and financial television.  It is what I am looking for, and maybe you should as well.

So far, my weekly guess about what will be important has been pretty accurate.  This week I foresee another bout of Fed Fixation.  It is a light week for the economic calendar and I do not expect much on the political front.  On Tuesday afternoon we will see the minutes from the March Fed meeting.  The Fed has made some major improvements in transparency over the years.  When I started in the business, you had to infer the result of the Open Market Committee’s decision by watching the New York Fed’s open market operations at “Fed time,” the regular hour for Fed intervention in the marketplace.  It took some experience to interpret what they were doing — system repos, matched sales, etc — and compare it to the Fed funds rate at the time.

The new approach is so much more sensible, both to communicate policy intentions and also to share information about discussion and dissent.

The Bearish Case

To summarize briefly, here are the various bearish positions:

  • The Fed should not even exist, so whatever they do harms the country;
  • The Fed should have allowed  various banks to fail, mortgage lending to cease, and normal commercial lending to end;
  • The Fed has stoked inflation and nothing that they do now can solve the problem;
  • The Fed actions have been totally inadequate to deal with incipient deflation, so we face multiple years of economic malaise, crashing housing prices, and high unemployment;
  • The Fed is “in a box” where any decision will exacerbate some problem.

A Calmer Look

The Fed has stepped in to fill the post-Lehman void in lending.  The expansion in the monetary base was large in the Lehman aftermath, but it has not continued.  The Fed also augmented a near-zero interest rate policy with an array of special lending facilities and direct purchases of securities.  Despite these actions, credit in the general economy remains tight.

The Fed communications have consistently indicated an emphasis on stabilizing and strengthening the economy with little concern about inflation.  There are now the first signs that some members of the FOMC want to prepare to reverse these policies.

“Prepare” is the operative word.  I expect the process of returning to a neutral policy stance to take about two years.  There will be many small, incremental moves along the way to neutral.  This gradual withdrawal of accommodation is not bearish.  It is a sign of strength.

Look for many commentators to fill pages and air time with speculation about the Fed’s exit strategy next week — and for the next eighteen months or so!

Last Week’s Action

Here is my take on the key data from last week.  I make no effort to be comprehensive, nor am I taking a viewpoint.  I will highlight what I found significant, trying to be objective.

The Good

There was some good news.

  • The ISM manufacturing report beat expectations and is consistent with an annualized GDP growth of 5%.  James Hamilton summarized the week’s data with “It looks good to me.”

 

The Mixed

For a change, the economic news was not so bad.

  • The March Employment Report.  The first month of significant net job gains is good news and it generated a positive response in holiday futures trading.  The payroll job gain was better than most expected if one considers the revisions to prior months and the size of the census hiring, only 48K so far.  The household survey has a larger margin of error (400K versus 100K), but it has now registered a net gain of a million jobs in three months.  This might be overstated, but it is probably not zero.

This is only a start.  The unemployment rate of 9.7% did not move, and will not until net job gains are higher.  An improving economy will also attract people back into the labor force.  The unemployment rate is a popular focal point, but not the earliest indicator of improvement.

Mark Thoma cites the same facts, but is discouraged about the prospects for improvement.  For the really bearish takes, you can see a roundup of comments from the usual suspects here.

Our Trading Forecast

Our own indicators are now bullish, and that was our vote in the weekly Ticker Sense Blogger Sentiment Poll. Here is what we see:

  • 87% (87% last week) of our ETF’s have positive ratings.  This is very strong.
  • The median strength is +31 (up from +24 last week).
  • 69%  (down slightly from 80%) of the sectors are in the “penalty box,” showing a continued high level of uncertainty.
  • Our Index Package now has a solid, positive rating, consistent with a gain in the market over the next three weeks.

Investment Implications

With a quiet economic calendar and a lull in earnings, it is time to be flexible.  I continue to pick up health stocks and economically sensitive names on dips.

 

Deficits: What is the meaning for the individual investor?

This week has a new avalanche of articles and TV programs about deficits.  All emphasize the maximum in scare tactics.  The sources are readily identifiable:

  • The politcians on the "outside."  This is currently the GOP, but it can work either way.  (Regular readers know that I made similar comments when President Bush was in office).
  • The perma-bears.  They are talking their books.
  • The top bloggers.  They have accurately identified their Internet audience and know how to go for page views.

None of this has anything to do with investment returns — unless you are willing to consider the opposite side.

Let me state this quite simply and clearly:

If you are going to wait for a widely accepted solution to the deficit problem, you are a PermaBear!

We have faced federal budget deficits for decades.  The Clinton Administration was the only surplus producer in recent times.  This problem will eventually be addressed.  As an investor, if you wait for the official solution, you will be far too late.  The key problem is that most observers want to "solve" the deficit question while we are still in the middle of an economic crisis.  Savvy public policy analysts take a different view.

Here are some hints:

  • It is going to take a bi-partisan commission so that neither party can be ostracized for cutting benefits.
  • Benefits will be cut — most prominently for social security recipients.  People are living longer so the ratio of beneficiaries to payees is totally out of proportion.  When the program was started, people only lived to 68 or so on the average.  It is past time to increase the official retirement age.  72 is the new 65!
  • Increased immigration will help.  Immigration has been demonized and mis-represented.  I was surprised at the consensus at Kauffman — supporters of immigration.

Where to Find Information

I am delighted to see the debate about lightweight versus long-form blogging.  Abnormal Returns has an excellent article on the subject.

This is an important subject that deserves some extra time.  Do you want to read short-form, bullet point pieces, or do you want more analysis?  Do you want something that caters to your pre-existing opinion, or something that challenges you to think?

An interesting question is whether gatekeepers like Abnormal Returns will start to make these distinctions.  One of the key lessons from the Kauffman conference was the overwhelming flow of information and the importance of knowing what to read. 

A Suggested Answer

In the aftermath of the passage of the health care legislation, there is renewed interest in deficits.  The actual experts on this subject are specialists in public policy — people who understand how the US government grapples with long-term issues.

To my amazement, the Kauffman Conference on Economic Blogging had a featured panel on this topic with no representation from a political scientist or public policy expert.  No wonder they concluded that we have no hope!  (I am still waiting for the link to the final video.  I'll update when available).

I wrote one of my best pieces on this subject a month ago, before it hit the mainstream radar.  If you want a politically neutral article — policy analysis and investment implications — it is still worth a read.  I got a few emails thanking me for clarifying a scary topic, so at least some have been helped.

Meanwhile, here is a good alternative — a discussion from Modeled Behavior.  Karl Smith is a young Public Policy prof whom I hope to meet some day.  This is a nice departmental discussion that captures many of the current issues.  It goes on for several articles and lots of video time, so it is a nice test of how serious people are about learning.  I recommend that you try it — at least for a few minutes.  Karl makes many strong arguments that deserve a wider audience.  There are a number of practical solutions that will enhance your understanding.

Summary

It is easy to write the short takes and the list of bullet points.  Writing a thoughtful, analytical piece takes hours.  Meanwhile, the market treats both equally.  Those sources that rely on revenue and page views have an easy choice of strategy.

As the financial noose tightens, MSM bloggers may be tempted into sensationalism and symbiotic relationships with the most popular "independent" bloggers.  We live in an interesting time.

ETF Update: Midcap Move

In addition to taking a couple of days off, I have had some computer problems.

It is a day late for our regular ETF update, but I will post the basics for our ratings below.  Those interested in a more complete description of our methodology can check any of our prior updates.

When I finish the upgrade to Windows 7 — the Vista experience was not good — I'll devote an article to the transition.

Meanwhile, here are the ratings from last Thursday at the close.  Those who subscribe to our weekly reports received timely updates, but I apologize for missing yesterday online.

Summary

The index package is still bearish on the market, but we are slightly long with specific sectors.  If I had written a full post, I would have emphasized the move in the midcaps and small caps.  That may still be the theme for next week.

This is really just a service for those who have interest in the updates, but are not subscribing to the email list (etf at newarc dot com).  Sign up there for a weekend email with the ratings.

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