Rosenberg On Why Fighting The Fed In Real Terms Has Been Very Successful

Tyler Durden's picture

Today, David Rosenberg has some good commentary which proves that those who say to not fight the Fed, may be 100% wrong when it comes to fighting adjusted for inflation, or as the case may be - deflation (conveniently, few talk about what bothers even seasoned hedge fund managers such as David Einhorn - i.e., "corn and oil"). And Rosie is spot on: the deflation in all credit-intensive purchases is accelerating, and will accelerate because the only thing that matters, as we have claimed for over a year, is the shadow capital/credit contained in the shadow banking system. That is the number that is collapsing at a rate of more than half a trillion per quarter. No matter what Bernanke does to M2 will even remotely offset this deleveraging deluge. Which is why we have long claimed that the only trump card Bernanke has is to devalue the dollar (both relative to other currencies and absolutely - relative to gold) to the point that its fate as a reserve currency is imperiled, ostensibly leading to a monetary crisis. One is free to name the resulting chaos in dollar denominated prices as one sees fit. But the bottom line is that as long as the shadow banking system continues to contract, which it will for years as the bulk of the funding came from European and Japanese banks: both of which are now gripped in austerity, and not really flooded with leveraged depositor money, everything else is merely a short-term blip on a long-term decline in both economic output and market terms. Also known as noise.

As for Rosie's amusing views on why Fighting the Fed has actually been a very successful strategy in real terms, read below:

DEFLATION REMAINS THE PRIMARY RISK

The San Francisco Fed just published another great report titled The Breadth of Disinflation.

The fact that one of the most reliable research departments within the Fed system could publish such a report two years into the greatest experiment with fiscal, monetary and bailout stimulus and reflationary policies speaks volumes. Frankly, what it tells us is that the 4.3% yield on the long bond is extremely attractive in real terms.

The report found that prices are deflating now for 17% of the goods and services that people consume — “evidence that price declines are widespread.” At the start of the recession, only 34% of the consumption basket was posting disinflation or slowing price momentum. That number is now at 72% — nearly three of four items in the basket is disinflating. This is the same ratio we saw in 1981 but back then we had Volcker doing everything he could to kill inflation. Today we have Bernanke doing everything within his powers from a 0% funds rate to radical expansion of the central balance sheet to reignite inflation and all he can do is throw matches on a wet towel.

Don’t fight the Fed, indeed.

Since the first cut in the Fed funds rate on September 18, 2007 …

  • The S&P 500 has gone from 1,520 to 1,223.
  • The unemployment rate has gone from 4.7% to 9.8%.
  • Industry capacity utilization rates have gone from 81.5% to below 75%.
  • The 10-year note yield has gone from 4.5% to below 3%.
  • Housing starts have gone from 1.183 million units to 0.519 million.
  • Median real estate values have gone from $210,500 to $170,500.
  • Core inflation has gone from 2.1% to 0.6%.

Well done!

Below we again highlight the appropriate SIRP strategy for such an environment:

  1. Focus on safe yield: High-quality corporates (non-cyclical, high cash reserves, minimal refinancing needs). Corporate balance sheets are in very good shape.
  2. Equities: focus on reliable dividend growth/yield; preferred shares (“income” orientation).
  3. Whether it be credit or equities, focus on companies with low debt/equity ratios and high liquid asset ratios — balance sheet quality is even more important than usual. Avoid highly leveraged companies.
  4. Even hard assets that provide an income stream work well in a deflationary environment (ie, oil and gas royalties, REITs, etc…).
  5. Focus on sectors or companies with these micro characteristics: low fixed costs, high variable cost, high barriers to entry/some sort of oligopolistic features, a relatively high level of demand inelasticity (utilities, staples, health care — these sectors are also unloved and under owned by institutional portfolio managers).
  6. Alternative assets: allocate significant portion of asset mix to strategies that are not reliant on rising equity markets and where volatility can be used to advantage.
  7. Precious metals: A hedge against the reflationary policies aimed at defusing deflationary risks — money printing, rolling currency depreciations, heightened trade frictions, and government procurement policies