Has Bubble Ben Shown His Hand?

Submitted by Leo Kolivakis, publisher of Pension Pulse.

Martin Roberge, Portfolio Strategist & Quantitative Analyst at Dundee Capital Markets, sent me his latest comment, Fed's Bernanke Has Shown His Hand: No Rate Hikes! Should Equity Investors Celebrate?:

On
Monday, Chairman Ben Bernanke provided an economic update at the
Economic Club of Washington. In our view, the key takeaway from his
speech is the non-conventional tightening mechanisms the Fed intends to
use when economic conditions warrant a tighter monetary stance. While
such mechanisms imply a prolonged period of low interest rates, history
shows that a trading-range environment for the stock market remains the
most likely scenario next year.

It may be just our imagination, but after reading Ben Bernanke’s speech
a few times, it seems that the next US monetary tightening cycle will
be initiated through Japanese-like monetary mechanisms as opposed to
conventional rate hikes. Indeed, the Fed spent a great deal of time
explaining how it can apply upward pressure on short-term interest
rates by: 1) raising rates on banks’ balances sitting at the Fed, 2)
using reverse repurchase agreements, and/or 3) reducing the size of the
Fed’s balance sheet.

The net
result is a prolonged period of low interest rates. Also, as in the 70s
and 80s, US monetary aggregates could become the mean to gauge the
Fed’s monetary bias. But what does it mean for equity investors?

It
has been 12 months since US Fed funds were cut to 25bps. A similar
status quo on short-term rates was seen in 2003-2004 (12 months),
1993-1994 (16 months) and 1983-84 (17 months). Interestingly, these
episodes are all post-recession periods and the chart at right shows
that the stock market has tended to behave erratically 12 months after
the last Fed cut. Obviously the apprehension of higher interest rates
is what causes market choppiness, with the possibility of double-digit
corrections.

But the key here
is that history suggests a trading-range strategy for equity investors
in 2010, where stock market weakness is bought and strength sold. This
is a view we have expressed and supported in recent strategy wires to
justify a neutral equity stance in our tactical asset allocation.

Bottom line: Consistent
with the Fed’s views, investors have priced out Fed rate hikes for the
next year. However, this does not necessarily represent a green flag
for equities. History suggests that prolonged periods of low interest
rates have translated into much market choppiness. Accordingly, a
trading strategy of selling strength and buying weakness may be optimal
in 2010.

While choppy markets look very likely, some managers still advise to just be long for 2010:

Amid
doubts about the economic recovery and a sense the stock market has
come “too far, too fast,” many are questioning whether the rally can
continue.

But such negativity is precisely why investors should
view dips like Tuesdays as opportunities, according to Jeff Saut of
Raymond James and Jon Markman, author, money manager and newsletter
writer.

“I never thought you could be a contrarian by being long
in a bull market but that’s where we find ourselves,” says Markman, who
pens the Strategic Advantage and Trader's Advantage newsletters.
I‘ve never seen a bull market were there’s so little joy. [investors]
are so morose. As if it’s going to fall apart right away.”

Looking
ahead to 2010, Markman said the best advice for investors is “just be
long,” recommending “risk assets” like emerging markets and the Russell 3000 ETF because it provides exposure to both small- and large-cap stocks.

Saut, who has been writing extensively about the “performance anxiety” facing underperforming fund managers, largely agreed with Markman’s assessment, although he thinks big-cap stocks are likely to outperform in the near term.

Both pundits also agreed gold’s long-term prospects remain bright even as it’s now suffering an overdue correction.

Still,
Saut was less ebullient than Markman, citing a number of “headwinds”
likely to hit the market in the middle of 2010, including higher
inflation and interest rates, more government regulation, the demise of
the “sugar high” from the 2008 stimulus, and the political risks of a
mid-term election.

“I feel pretty good into the first quarter of
next year…there’s still way too much cash in institutional coffers,”
the strategist says. “It’s important to be long but once you get into
the second and third quarters you’re going to start to see some
headwinds. That doesn’t necessarily mean stocks will go down.”

If you listen to the interview,
the parallel to 1991-92 is worth noting because everyone expected a
double-dip recession back then that never materialized. What I see in
2010 is speculative pockets going into specific sectors or stocks.

Clearly
Bubble Ben has shown his hand but don't be so convinced that the Fed
will not raise rates in 2010. If the recovery comes in stronger than
anticipated, you might see some significant rate hikes in the second
half of 2010. That's when the markets will really get interesting.

Comments

[Deep]

Why does everyone extrapolate prior recessions as a benchmark for this recovery. We have never witnessed a credit collapse of this magnitude. To say that this is how we recovered coming out of previous reccessions so we will come out the same way is very weak. Leo can you expalin this.

[Anonymous]

Here is a couple of Newspaper articles from the last credit collapse/Depression.
No matter what they did, it could not be stopped. There is no way to stop this one either. It should be pretty clear by now, if not, it soon will be. Cheers

Bank of America sees bottom of depression passed, “more prosperous business conditions in 1931”; however, recovery after prolonged depression starts almost imperceptibly, and as yet it's impossible to judge how early in 1931 it will begin.

Commerce Sec. Lamont: “We have already weathered the worst of the storm and signs of stability and recovery are appearing.” Cites few wage cuts and strikes compared to earlier depressions.

[Doc]

To be fair they were on a gold-standard back then and couldn't do all this "stimulus"/QE stuff back then...

So Leo might have a point that the economy might start to overheat by next year.

[Leo Kolivakis]

We have also never witnessed unprecedented fiscal, monetary and quantitative easing of this proportion in such a coordinated fashion. If a stronger than expected recovery develops in the second half of 2010, many market participants will be caught off guard because most expect a relapse as the stimulus fades and the Fed to stay on the sidelines.

All I am saying is what if the recovery is stronger than anticipated, forcing the Fed to hike rates in H2 2010? If anything, most skeptics are all thinking like you - ie. 2008 was a watershed year and we are heading right back down again in 2010. Maybe we are but it's more likely the strength of the recovery will surprise all of us, including yours truly.

[El Hosel]

 "what if the recovery is stronger than anticipated"

What if everybody is cooking the books? What if we are trillions of dollars in debt. What if "investors" lose confidence in our financial system? What if truth and transparency leak into the equation?

http://www.youtube.com/watch?v=sw_x8XtngGM

[faustian bargain]

If I sprouted wings next year, I might be able to fly unaided. That would be pretty interesting too.