Did The Fed Blow It?

Via Pension Pulse.

Kristina Peterson of Dow Jones Newswires reports in the WSJ, US Small-Cap Stocks Plunge As Investors' Economic Anxiety Climb:

U.S.
small-capitalization stocks plunged Wednesday in their biggest two-day
drop since early June, highlighting the anxiety that flooded the
market over worries of a global economic slowdown.

The
Federal Reserve's more cautious assessment of the economic recovery
and data showing slower growth in China sent the broad market into a
tailspin Wednesday. Small-caps, thought to sink further in times of
economic weakness, fell most steeply as investors fled from riskier
assets.

The Russell 2000 index of small-capitalization
stocks tumbled 25.97 points, or 4.02%, to 620.39, its third largest
point drop of the year.

The Standard & Poor's SmallCap 600
index skidded 13.13, or 3.80%, to 332.16, its fourth biggest point and
percentage drop of 2010.

Both indexes wiped out their
year-to-date gains on Wednesday. The Russell 2000 is now down 0.80%
year-to-date, while the S&P 600 is off 0.14% since the year's start.

"Small caps had a nice start to the year as they tend to
outperform coming into an economic recovery, but that recovery is now
much more doubtful," said David Carter, chief investment officer at
Lenox Advisors. Investors interpreted the Fed's statement as an
"about-face," reversing its earlier more optimistic view of the
recovery, he said.

Cyclical
sectors led the broad decline in small caps as worries mounted over
whether the economy could enter a second slump. Materials weakened as
investors fretted that the slowing growth in China could cut into
demand.

"If China can't pull along the global economy,
who can?" asked Carter. Agricultural products company American Vanguard
plummeted 88 cents, or 11%, to 7.38, on the New York Stock Exchange.
Century Aluminum fell 88 cents, or 8.1%, to 10.01.

Energy
stocks took the steepest tumble Wednesday. Investors avoided
commodities as the dollar surged, sending the price of oil down 2.8% to
settle just above $78 a barrel. Oil-well-services provider Basic
Energy Services (NYSE) fell 99 cents, or 11%, to 8.34.
Offshore-drilling company Seahawk Drilling shed 93 cents, or 10%, to
8.08.

Safe-haven consumer staples slid, but posted the
most modest drop. Gainers included tobacco company Alliance One
International (NYSE), up 4 cents, or 1.2%, to 3.35, and snack-foods
maker Lance, which rose 4 cents, or 0.2%, to 22.04.

The drop in energy and commodity stocks slammed Canada's main stock index as it fell to its lowest level in nearly three weeks. The Canadian dollar lost more than a penny as stocks took a beating.

After the close on Wednesday, tech giant Cisco Systems was down nearly 8% as its CEO warned that a return to normal economic conditions would take longer than previously expected.

It's pretty much all doom & gloom again, prompting some market observers to ask whether the Fed's move against deflation will end up backfiring:

If
you weren't worried about deflation, you may be now—thanks to the
Federal Reserve's latest move to jumpstart the languid economy.

In
fact, some economists think the central bank's implicit concern about
falling prices could help bring about the very situation the Fed is
trying to avoid.

"This gets to
be a gamesmanship situation," says economist A. Gary Schilling. "On the
surface, the Fed is reacting to the threat of deflation and a weak
economy. Does it have deflationary implications? I think it does
because it says the Fed is concerned. They're obviously preparing more
and more for it. People say, 'Maybe I ought to prepare for it?'"

With
both Wall Street and Washington looking to the central bank to do
something else to revive what many see as a flagging growth, the Fed's monetary policy committee Tuesday said
it would "help support the economic recovery in the context of price
stability" by buying longer-term Treasury securities, while downplaying
inflation.

"The
Fed didn't use the D word in its statement but that's certainly
implicit in its thinking," says Scott Anderson, senior economist at
Wells Fargo.

After
the statement's release, stock prices cut losses and more importantly
Treasury prices rallied further. But investors woke up Wednesday and
essentially asked, "What just happened?"

In a double-take Wednesday morning, almost every asset class, from gold to oil to stocks, fell ... except Treasurys—the prime beneficiary of the Fed's move—whose monster is inflation.

Few
economists see actual deflation in the wings. But given the the
economy's slow growth, marked by weak demand, and a spate of recent
reports showing falling prices for goods and services, they say
deflationary expectations are real and growing.

Economists
admit that though the price of many durable goods has been falling, if
you take food, housing and oil out of the consumer price index, prices
are decidedly higher. What's more, wages—a key ingredient in the
deflationary equation—are not falling.

"It isn't deflation per se that bothers the Fed, it's deflationary expectations," explains Schilling.

Economists
say Fed boss Ben Bernanke and the FOMC members may have wanted to seem
assertive and reassuring in its policy initiative, but at this point
the move appears to have backfired.

"It's
almost as if their statement now is contributing to deflationary
expectations," says Chris Rupkey, chief economist at Bank of
Tokyo-Mitsubishi, who otherwise does not subscribe to the deflation
argument.

Economists
and money managers say the Fed clearly intends to push intermediate
and long term rates lower, much as it has with short term rates, to
encourage demand and risk, whether it's lending and borrowing or
production and consumption, all of which supports price appreciation,
not depreciation.

"They're hoping it
creates a positive economic impact to avoid that [deflation]," says Jim
Awad, managing director at Zephyr Management.

Much like with the recent rally in Treasurys, analysts and investors are rightly asking just how low the Fed can go.

A relentless push has its hazards. One is a perpetual flight to quality and the safe haven of Treasurys.

Schilling,
for instance, says he's still buying 30-year bonds, now yielding about
four percent and headed to three percent. That's probably a safer bet
than stocks yielding a big return anytime soon, he says.

"It's
OK if they can jawbone long-term rates lower," says Rupkey. "It's not
the Fed pushing rates lower today. it's the Dow falling 200 points
that brings rates down. If it's also hurting the stock market, the
impact of wealth loss is going to overwhelm the lower prices and
potential consumption."

Another
risk is that cheaper and cheaper money becomes another reason for
consumers and businesses to wait to do anything, defying the normal
inflationary cause and effect.

"They're
pumping up money as much as they can, which is supposed to be
inflationary," says Ken Goldstein of the Conference Board. "But in the
short term you do have kind of a deflationary pressure to it. It's
about timing."

Meaning , if the strategy works, it reinflates the economy, before deflation sinks it.

Alright,
let me give you my take on Wednesday's action. The media will spin it
as "pure panic", but this is just another day for Wall Street crooks
to make a killing. After the Fed's announcement, they brought the
market up, a classic head fake before they cut risk across the board on
Wednesday.

Don't be fooled. This market
is so corrupt, so manipulated, that it's no wonder the big banks and
their elite hedge fund clients are the only ones that can navigate
through it properly, making a killing in the process. Multi-million
dollar computers performing high-frequency trading (HFT) provide the
illusion of an "imminent catastrophe".

Total
rubbish. I really wonder which institutional investor was dumb enough
to sell stocks after the Fed's announcement. I bet you elite hedge
funds and big banks' prop desks are loading up on risk
assets, using this as another opportunity to make enormous profits.

All
this gloom & doom is way overdone. I don't know if the bounce will
happen this week or next week, but it will bounce back and global equity
markets will rally sharply. In fact, all risk assets will bounce back
because asset classes are highly correlated.

Cheap
money may not benefit consumers and businesses in the near term, but it
means more cheap financing for Wall Street's financial elite to
continue borrowing at zero and investing in risk assets all around the
world. They'll continue trading, not lending.

And what about pension funds? On Wednesday, the Canada Pension Plan Investment Board announced its Q1 fiscal 2011 results:

The
CPP Fund ended the first quarter of fiscal 2011 on June 30, 2010 at
$129.7 billion compared to $127.6 billion at the end of fiscal 2010, on
March 31, 2010.

The $2.1 billion increase in assets after
operating expenses this quarter was the result of contributions, which
totaled $3.8 billion in the first quarter, offset by an investment
return of negative 1.3%, or negative $1.7 billion. The investment
result was primarily due to the decline in public equity markets, and
this was reflected in CPPIB’s public markets investment portfolio.

As
global financial stimulus efforts tapered off and concern about
economic conditions in Europe increased, many public equity market
indices dropped significantly in the three-month period ended June 30,
2010. For example, the S&P 500 fell by 11.9%, and the TSX was down
6.2%.

“This was a challenging
quarter for public equity markets around the world, many of which
experienced double-digit declines,” said David Denison, President and
CEO, CPP Investment Board. “This was also a quarter where the CPP Fund
benefited from diversification into private equity, real estate,
infrastructure and private debt holdings.”

For the
five-year period ended June 30, 2010, the CPP Fund has generated an
annualized investment rate of return of 3%, or $13.8 billion of
investment income. For the 10-year period ended June 30, 2010, the Fund
has generated $36.6 billion in investment income, reflecting an
annualized rate of return of 5.1%.

Investment Portfolio Update

CPPIB investment teams were active on a broad range of
transactions during the first quarter. Completed investments included
the acquisition of ownership stakes in 1221 Avenue of the Americas and
600 Lexington Avenue in New York City, a U.S. shopping centre
acquisition joint venture with Kimco Realty Corp., a property
development joint venture in Australia with Goodman Group, and the
acquisition of a 17.5% stake in oil sands developer Laricina Energy.

Transaction
activity has continued since the end of the first quarter. In July,
CPPIB submitted a conditional proposal to acquire Australian toll road
operator Intoll Group, whose assets include a 30% interest in the 407
ETR in the Greater Toronto Area, and through an entity jointly owned by
CPPIB and Onex, reached an agreement with Tomkins plc to acquire all
of the issued and to be issued share capital of Tomkins, a global
engineering and manufacturing group. CPPIB also recently entered into a
joint venture with U.K. property manager and developer Hammerson plc
to acquire an office building at 10 Gresham Street in the City of
London.

“We continue to focus on
putting to work our comparative advantages including scale,
predictable cash flows, and the long investment horizon of the CPP Fund
to diversify our global portfolio,” said Mr. Denison. “We now have in
place the resources and expertise to execute private asset transactions
such as these most recent ones around the world.”

“Looking
ahead, while we see a modest global recovery underway, we also see a
number of challenges, particularly in international credit markets.
Since access to credit markets remains a critical element in our
ability to complete private asset transactions, we expect that they
will continue to be difficult to execute throughout the balance of
fiscal 2011. Notwithstanding these difficulties, this environment
affords us opportunities to earn attractive risk adjusted returns,
especially in the area of private debt. As a global organization, we
also have the benefit of being able to invest in geographies that offer
the best forward looking return characteristics on a risk adjusted
basis and, as a result, we are continuing to pursue expansion of our
investment activities into emerging markets,” Mr. Denison said.

At the end of June 2010, approximately 25% of the CPP Fund, or $33 billion was invested in private assets.

Given CPPIB's asset mix, these results shouldn't surprise anyone:

• Equities represented 53.9% of the investment portfolio or $69.9 billion. That amount consisted of 40.8% public equities valued at $52.9 billion and 13.1% private equities valued at $17.0 billion.

• Fixed
  income, which includes bonds, money market securities, other debt and
  debt financing liabilities, represented 32.0% or $41.5 billion.

• Inflation-sensitive assets represented 14.1% or $18.3 billion. Of those assets,

  • 6.1% consisted of real estate valued at $7.9 billion
  • 4.7% was infrastructure assets valued at $6.1 billion
  • 3.3% was inflation-linked bonds valued at $4.3 billion.

Keep
in mind that CPPIB only reports results on its private markets once a
year, when their annual report comes out, so the quarterly results
pretty much follow what is happening in global stock and bond markets
(ie. beta).

A key question to consider is how are most pension
funds going to react to the Fed's announcement? How are they going to
deliver 8% actuarial return in this environment dominated by high-frequency trading and outright manipulation of the markets? You can bet
that senior pension officers around the world are holding asset
allocation meetings following the Fed's announcement.

Finally, I
leave you with a clip where John Ryding, of RDQ Economics, and Brian
Fabbri, of BNP Paribas, discuss whether the Fed's made a mistake. As I
stated in my last comment,
there is no choice but to continue reflation policies, and while
markets are selling off, I still think this dip will be bought hard. But
they will first scare all the weak hands away, much like they did in
late October 2009 when everyone feared another Black Monday.

Comments

[Assetman]

Man, your really a piece of work, Leo.

Sure, every bald and bearded economist in the world is trying to draw parallels with the U.S. to something out there... and Japan happens to be it.

Here's the problem, Leo.  No one knows how this will play out.  In some respects, we are in totally new territory when it comes to applying monetary prescriptions.

To this date, none have been terribly effective.

Nope, this is not Japan. As you pointed, Japan's demogrpahics were worse.  But they had export and domestic saving benefits that the U.S. cannot match.  But the biggest difference is that Japan did not do their market manipulating activities in the dark.  The U.S., on the other hand, has had just about everything from view.

But none of that matters.  We have gone through 18 months of emergency monetary policy, starting with ZIRP.  We've had about $2 trillion effective in QE.  These are insanely extreme measures.

And now?  Economists all over the globe are lowering U.S. GDP expectations.  What recovery we had (mostly due to fiscal stimulus) is fading, and it WILL have an impact on corporate earnings.

As for QE, it's highly debatable how much of a positive impact it's really had-- excpet that it's helped the banks a ton (again).  Given the money trail, you can reasonably bet that net QE credits filtered their way into all risk assets, especially early on in 2009.  But fiscal stimulus had arguably much more direct and real economic impact.  The problem with QE is that it's only directly helped the banking sector-- both last time and this time.  And more people are beginning to figure this out.

I understand your deal with reflation and market manipulation... and resulting bubbles.   Hey, that's worked, as we're all looking in that rear view mirror.  But we are at a stage where playing the reflation game becomes a high risk and low reward affair.  As the 2000 equity bubble played out, there wasn't a whole lot of time to make your move as the economy decelerated.  It's likely to be even quicker this time, due market concentration and high stock correlations.

Bruce is exactly right on this issue, and you've been warned a million times.  While we probably are not at "red alert", we are at "yellow" and clearly moving in that direction.

You either see it now for what it is... and the extent of what your reflation/manipulation thesis can take you... or you don't.  As time goes by, I feel less empathy for you.

[Waterman Jim]

easy assman, leo's article wasnt that bad,

I think in the past he was too smug about the market going up while all the bears were losing their honey.

i dont think he likes QE, hes just living with it, just like i'm learning to do.

its kind of like trying to get along with your ex wife. 

[Assetman]

Well, waterboy jimmy... of course Leo is as harmless as they come, ya think?  He's just that incessantly constant reminder that some people will just never get it.

It doesn't matter whether any of us like QE.  The issue is whether you should be making reflation/risk asset purchase decisions based on it.  We had a very nice rally based on extreme monetary AND $750 billion in fiscal policy.  And Leo had been pretty spot-on, until the sings of stimulus started wearing off.

Now that is ending, Leo expects that $200 bil. a year in QE will have a similar impact in moving the needle.  It won't.  Normally QE woudn't be that much of an ex-wife factor, except that it funnels capital into capital destroying entities.  You know, like an ex-wife taking your alimony payments and going to the casino kind of thing.  Given that my first and only wife doesn't do stupid things with our money, perhaps I can't relate to the argument.

[Waterman Jim]

you must know how to pick-em.

buy her some flowers tonight and count your blessings, your a lucky man.

hope your right, but i dont trust the bastards.

seems like a great time for TPTB to make more excuses to put us deeper into debt...

while maintaining the "peace".

[Assetman]

I agree about the trust issue, and that may be the eventual factor that makes everything implode.  Who knows when that is?

At this point, TPTB may well execute the same gameplan... but I really wonder if the effect is going to be the same in the markets.

The gist of this is that we just don't know.  Anyone who is making an all in bet on reflation at this point is just plain nuts, IMO.  But I'm just as afraid as making that same bet on deflation...

[Oso]

Bruce - i dont think Leo has ever said QE is a "good" thing.  Yourself, Rosenberg, and other deep thinkers are absolutely correct, never in history has monetization ended in anything but tears.

However, being realistic about this situation, ESPECIALLY heading into mid-term elections, there is a very low chance the powers that be will let equity markets slide.

We've seen this play before, so everyone should know how to run it.  Remember, the days the Fed bought treasuries first time around were the days the market went up and the dollar went down.  Rosenberg is a great economist.  But, he is an aweful trader, and an average mid-range investor.

 I think thats all Leo is ultimately saying.

Also, i dont think protracted deflation will happen.  We will have a currency crises and instant hyper-inflation well before that.

BTW, an absolute pleasure seeing two of the sharper minds here square off against each other!

[Bruce Krasting]

The powers to be you refer to have ZERO, repeat ZERO ability to influence the equity market. To think they do is is a fatal mistake.

[Waterman Jim]

common bruce, dont you think we would already be in a depression if it weren't for the infinite credit extended by TPTB?

[ColonelCooper]

Goood comment.  Were the last two days our actual falling off the right shoulder?  Probably not quite.  TPTB will certainly use up every trick in the bag, and our bumpy ride may continue for a while yet.

All this gloom & doom is way overdone. I don't know if the bounce will happen this week or next week, but it will bounce back and global equity markets will rally sharply.

Leo could simply do us all a favor if he would lay off the Pollyannish bullshit.  Maybe, just maybe, if Leo would approach things with a "ride it down" perspective once in a while, people would cut him some slack.  But keep pumping this non existent recovery, and he's starting to look like this:

http://www.youtube.com/watch?v=s27Oq5ot0ZI

[Howard_Beale]

Gee, and you think that the powers that be had any control of the equity market before the Presidential election in 2008? NO. They did not. Nuff said.

[Problem Is]

The Maple Leaf is Tarnished Again...
As all Amerikan stars & stripes swim suit wearing critic Bruce kicks verbal sand in the face of milk toast white,  scrawny Canadian Leo on the investment beach...

Charles Atlas Says:
"80lbs scrawny, Canadian milk toast white Leo..."

"Don't let those stars & stripes swim suit wearing bullies kick sand in your face..."

"You need my exclusive verbal body building course for weaklings..."

"You too can have huge rhetorical muscles like this!"

<Charles Atlas flexes giant biceps>

[jdrose1985]

nobody knows how this ends because it never REALLY ends, the games will play along with the waves of antiquity.

Reflation is over, now deflation, next inflation, ad infinitum.

[Kayman]

DosZap

WHAT ??? Don't confuse him with facts.  Of course, all the necessities of life are cheaper all the time, wages and employment are on an upward slope, Chinese imports do not cause unemployment in the West, and you can trust your politicians to always tell you the truth.

The brown paper bag dropped off at the Senators doorstep every Sunday morning is just a picnic lunch.

You, my friend, are not being an onside kinda guy. Shame on you.

[Dr. Sandi]

The brown paper bag dropped off at the Senators doorstep every Sunday morning is just a picnic lunch.

The brown paper bag dropped off at MY senator's doorstep every Sunday morning isn't a picnic lunch. But it contains rich organic material and IS on fire. And the dumb bastard stomps it out every single week!

[jakoye]

This is hilarious:

"Economists admit that though the price of many durable goods has been falling, if you take food, housing and oil out of the consumer price index, prices are decidedly higher."

Um, aren't food, housing and oil the basic stuff that everyone needs to survive? So why would you ever take the most important items that everyone needs out of the inflation equation?

[DosZap]

"Economists admit that though the price of many durable goods has been falling, if you take food, housing and oil "out" of the consumer price index, prices are decidedly higher. What's more, wages—a key ingredient in the deflationary equation—are not falling."

Well, someones on CRACK again.

Wages?,what wages?. No one I know is getting raises,lucky to have a full time job, much less increased WAGES.

FOOD is cheaper?,OIL is cheaper?,again, let me know where you buy your Crack, I'll find another Dealer.

Food prices are UP 25-40%.

Oil should be under $70.00 a barrel,on demand, or should I say, lack therof?.

What am I missing here?.................what else do they leave to BE higher?.

[faustian bargain]

If we keep cutting jobs, we can keep wages at the same level indefinitely!

[animalspirit]

I just had this discussion with my sister.  Her 30th year high school reunion was a couple weeks back.  80 or so kids graduated.  One of them scored on Wall Street, big time, and thus if you took the average income for those 80 people for 2009 it was over ten million dollars each -- though only a handful made over 6 figures.

[Yes, I know increases in wealth don't translate evenly to "wage increases", but for purposes of explaining averages and the impact of outliers, works fine.] 

Oh, and Federal wages are going up ... exceeding private 9 years in a row! http://www.usatoday.com/money/economy/income/2010-08-10-1Afedpay10_ST_N.htm

[Assetman]

Wages are flat on average.

Aggegate incomes are down significantly.

Which one of those do YOU think is more meaningful???

[jakoye]

Hah! Seems like the same line struck both of us as rather odd. Good points!