See why the Fed is unlikely to taper in December, but Q1 14 is much more likely. Read a preview of the highlights from the week ahead.
Thinking like the Fed
To know your enemy, you must become your enemy -Sun Tzu
In war, poker, chess and many other endeavors, wise old hands will advise you to think like your opponent. We’ll try a related idea here by seeing if we can think like the members of the Federal Open Market Committee (FOMC). Specifically, we’ll pretend to write part of the statement for the FOMC’s December 17/18 meeting.
Bitcoin could become a major means of payment for e-commerce and may emerge as a serious competitor to traditional money-transfer providers, BofAML notes in a report today, adding that as a medium of exchange, Bitcoin has clear potential for growth, in our view. Despite Greenspan's inability to find "value", BofAML prefers not to call the crypto currency a bubble, and assigns a maximum fair-value of $1,300, but does warn that the 100 fold increase in Bitcoin prices this year is at risk of running ahead of its fundamentals.
On the surface, the first revision to the Q3 GDP print, which initially came at 2.8%, was tremendous: at 3.6% well above the 3.1% expected, nothing could be better. Unfortunately, once again reading between the lines shows that all the "growth" was completely hollow and entirely on the back of the ongoing massive inventory accumulation, which rose from 0.41% in Q2 to 0.83% in the first Q3 revision, to an epic 1.68% in the current revision, or nearly half of all the "growth" in the economy. As for the most important component of GDP - personal consumption it once again declined, and dropped from 1.24% of the GDP number in Q2 to 1.04% in the first revision, to just 0.96% in the final Q3 revision - this was the lowest consumption contribution to GDP since Q3 2009! Bottom line: the US consumer is getting ever weaker, even as retailers and producers are stocking up more and more inventory to take advantage of the lack of consumer spending power.
Previewing the rest of this week’s events, we have a bumper week of US data over the next five days, in part making up for two days of blackout last week for Thanksgiving. Aside from Friday’s nonfarm payroll report, the key releases to look for are manufacturing ISM and construction spending (today), unit motor vehicle sales (tomorrow), non-manufacturing ISM (Wednesday), preliminary Q3 real GDP and initial jobless claims (Thursday), as well as personal income/consumption and consumer sentiment (Friday). Wednesday’s ADP employment report will, as usual, provide a preamble for Friday’s payrolls.
With every other bear throwing in the towel left and right these days, we fully expected that the latest letter by SocGen's Albert Edwards would have something about "how much he hates looking at himself in the mirror, but..." Luckily none of that happened. Instead we were greeted by the sharp insight and keen intellect that we have grown to expect from AE, and that have disappeared from the repertoire of so many other sellouts and lemming cheerleaders. Ironically, the topic of Edwards' latest piece is precisely the chart above - the explosion in future margins, or rather the complete lack thereof. But not only that. For everyone else who has dutifully thrown in the towel, very much as the Chairman expects, Edwards has a few words: 'The doomsayers who predicted that this recovery was on the verge of faltering have been proved wrong, and like the boy who cried wolf, can be safely ignored by the market. Yet that is exactly what happened in 2006 with the US consumer and housing boom, where the voices of caution had been so wrong, for so long, that their Cassandra-like utterances were ignored. Cassandra?s forecasts may have been ignored, but they proved to be correct. Investors demand a sign of when to get out and that trigger may have just arrived."
From consumer and retailer surveys to quantitative data such as household spending and private jet bookings, ConvergEx's Nick Colas has amassed a collection of 10 clues about this year's holiday shopping season. On the plus side, disposable personal income and consumer spending on discretionary items are rising, and travel to Palm Beach via private jet is quite popular this Christmas season. However, consumer confidence surveys are particularly weak, and consumer debt has ballooned to a 5-year high. Roughly equal parts good and bad, Colas' collection of holiday spending indicators points to a mediocre (at best) 2013 shopping season (as we noted earlier).
Valuations still matter. Assuming that one is 'investing' as opposed to 'speculating', initial valuation (i.e. the price you pay for the investment) remains the single most important characteristic of whatever one elects to buy. And at the risk of sounding like a broken record, “initial valuation” in the US stock market is at a level consistent with very disappointing subsequent returns, if the history of the last 130 years is any guide. Without fail, every time the US market has traded on a cyclically-adjusted P/E (CAPE) ratio of 24 or higher over the past 130 years, it has been followed by a roughly 20 year bear market... but there are plenty of other fish to fry...
Somehow, Fed head Bill Dudley has managed to encompass the entire "we must keep the foot to the floor" premise of the Fed in one mind-bending sentence:
- *DUDLEY SEES 'POSSIBILITY OF SOME UNFORESEEN SHOCK'
So - based on an "unforeseen" shock - which he "sees", and while there are "nascent signs the economy may be doing better", the Fed should remain as exceptionally easy just in case... (asteroid? alien invasion? West Coast quake?)
Earlier today we reported that the Japanese cries of "more QE" have not only started but are getting progressively louder, when after a massive initial surge in the first half of the year following an epic currency dilution, the Nikkei's performance since May has largely been one big dud, which is putting not only the psychological "wealth effect" at risk, but also is tearing Abenomics apart, since perhaps the only key variable for the Prime Minister's plan of "growth" is the constant increase in the stock market, much the same as in the US. But while the market has gone nowhere fast, it is the economy that is truly starting to crack at the seams, as was confirmed hours ago when Japan reported that in the third quarter its economy grew an annualized 1.9%, following a quarter when the GDP grew at more than double that pace or 4.3%, which in turn succeeded a quarter with 3.8% growth. What's worse, in nominal terms, the actual third quarter growth was a paltry 0.4%: the lowest in all of 2013 while actual nominal consumption plunged to the lowest level since just after the start of Abenomics.
With Ben Bernanke's tenure closing, many financial TV pundits delight in touting the stellar performance of Ben Bernanke as Federal Reserve Chairman with just a couple months left in his term. Before the re-writers of history begin spinning performance, we thought why not compare Mr. Bernanke against all the other Federal Reserve Chairman to determine which Chairman deserves recognition. Bernanke's overall score across all factors was the lowest (let the spin begin counterfactualists). The data suggests that Mr. Bernanke ranks last in performance between the two mandates since 1948. Quite an accomplishment considering what events transpired during the last 60+ years; Korea & Vietnam, Oil Shock, high interest rates, etc...
What inventory boosts give in the current quarter, inventory lack of boosts take from future quarters. At least that is what Goldman's Jan Hatzius just stated in his note summarizing not only the just released Q3 GDP, but his first Q4 tracking forecast, which he cut from 2.0% to 1.5%. To wit: "GDP grew more quickly than expected in Q3, but the surprise came mainly from a larger-than-expected inventory contribution and a smaller-than-expected decline in government spending. Consumer spending and business fixed investment were less strong. Initial jobless claims declined as expected with no special distortions noted by the Labor Department. We started our Q4 GDP tracking estimate at 1.5%."
A day of fireworks that started with the stunner by Goldman's head of the ECB has just gotten its second wind following the preliminary announcement of Q3 GDP, which roared from 2.5% to 2.84%, far above expectations of a 2.0% annualized number. On the surface this was a bad number for Taper watchers, as it may mean the Fed will actually have to moderate its monthly flow precisely at the time when the ECB was forced to do "whatever it takes" in its fight with inflation, however a quick look at the internals shows that once again there is much more than meets the eye: because while the headline print was the strongest since Q3 2012, the core driver of economic growth, Personal Consumption, grew 1.5% below the expected 1.6%. Specifically, of the 2.84% number, PCE was just 1.04%, the lowest since Q2 2011!
As the S&P 500 continues to push to one new high after the next, the bullish arguments of valuation have quietly given way to "it's all about the Fed." The biggest angst that weighs on professional, and retail investors alike, are not deteriorating economic strength, weak revenue growth or concerns over the next political drama - but rather when will the Fed pull its support from the financial markets. For the Federal Reserve, they are now caught in the same "liquidity trap" that has been the history of Japan for the last three decades. Should we have an expectation that the same monetary policies employed by Japan will have a different outcome in the U.S? More importantly, this is no longer a domestic question - but rather a global one since every major central bank is now engaged in a coordinated infusion of liquidity. Will the Federal Reserve "taper" in December or March - it's possible. However, the revulsion by the markets, combined with the deterioration of economic growth, will likely lead to a quick reversal of any such a decision.
Looking ahead, Thursday will be a busy day with the ECB (plus Draghi’s press conference) and BoE meetings. Some are expecting the ECB to cut rates as early at this week although most believe the rate cut will not happen until December. Draghi will likely deflect the exchange rate’s relevance via its impact on inflation forecasts. This could strengthen the credibility of the forward guidance message, but this is just rhetoric — a rate cut would require a rejection of the current recovery hypothesis. They expect more focus on low inflation at this press conference, albeit without pre-empting the ECB staff new macroeconomic forecasts that will be published in December.