Fifty Shades of Grey


“Professor Marvel never guesses, he knows!” – The Wizard of Oz

The wait is over now – and so a new one begins. The long-awaited monetary taper was announced by Federal Reserve chairman Ben Bernanke on Wednesday: It is exactly zero, leaving us to wonder when some taper does come, if ever, how much will it be, and with the added comfort of a new wait to see if the government shuts down in ten days, and whether we default on debt payments shortly after that.

Regarding the latter, there’s the usual division between the media who by trade and custom are sounding alarms about potential ruin, and the investment community, opting for the more common approach of blaming whichever side of the government they didn’t vote for. For the most part however, the trade is shrugging it off for what it appears to be: Another Punch-and-Judy show designed to entertain the commando wings of the two parties before they embark – most regretfully, dear brothers and sisters, most regretfully! – on a “forced” compromise for the good of the country. Then they can get back to the higher priority business of blaming each other for whatever is wrong in the world that day. Perhaps the House will vote to repeal Obama-care again.

They’re all talking their own book, of course, from a media that thrives on drama to the investors who don’t. As for all the political speeches and press conferences supposedly made on our behalf, “the American people,” those self-styled valiant efforts that are really campaign clips to rally the faithful at the next primary election, well, last year I was taken in by the dramatic show of intransigence; this time around I’m staying in my seat until it’s over.

Bernanke and the FOMC caught markets by surprise. Some observers think they both whiffed on a chance to get a taper started that had already been priced into the market. I am one of those, and recommend this clip of another, Stanley Druckenmiller, in a CNBC interview (skip to the 6:50 mark).

The immediate market reaction to the no-taper was a big spike in the price of all assets – bonds, stocks, metals, emerging markets – but the short-covering nature of it was immediately evident. Prices sagged the next day from the opening right up to Friday’s close, giving back nearly all of the post-FOMC move.

While it isn’t possible to know yet what the aftermath of the Fed’s long (and large) expansion will be, it worries me that its policy committee seems to be of the opinion – on balance – that any exit won’t present a problem. Bernanke specifically stated it wouldn’t, though he had the decency to look down at the table as he did so, giving me the impression of something amiss. It may well be that, as some speculated afterwards (including Bill Gross), his answer was predicated on the presumptive ascension of current vice-chair Janet Yellen to the Fed throne.

Stocks had started the week off with a big rally that was ignited by the withdrawal of the candidacy of Larry Summers to succeed chairman Bernanke. It clearly belied the oft-spoken complaint that Summers would be Wall Street’s boy; indeed of all the top candidates, the Street most feared the strong-minded former Treasury secretary. I was neither dazzled nor dismayed by the possibility of a Summers chair – like many others, I respect his intellectual firepower while worrying about his less-than-diplomatic tendencies. His tenure as president of Harvard didn’t lack for controversy, and the infamous remarks about women and mathematics had many of the most influential women of his generation lined up against him – especially with the other lead candidate being a woman.

That would be vice-chair Yellen. She is certainly qualified for the job, but her apparent status as being even more dovish than Bernanke is not one that fills me with comfort. I wasn’t in favor of the latest round of quantitative easing, and am somewhat uneasy about an academically-dominated policy committee that seems increasingly confident it can push whatever button desired without fear of consequence. Central banks cannot know whether they can play this game forever, but they should know it’s a fearful risk to try.

St. Louis President James Bullard gave an interview on Bloomberg Friday morning that made me long for the days of Alan Greenspan. Bullard, who looked tired, was clearly trying to be as equivocal as possible with his answers, yet the press was quick to seize upon some of the remarks as signifying some sort of major policy view, like a possible October taper. He really didn’t say anything.

One of the oddities of life is how often a worldview comes into existence not as original thought, but in opposition to some common complaint. Thus, while Greenspan’s tenure as Fed chairman was generally held in high regard while he was running the show (less so since he left), the chief complaint about him was a near-complete inscrutability on questions of policy. His ability to obfuscate was legendary.

Bernanke’s accession was marked from the outset by an avowal to communicate clearly and be more transparent; in his words, one could easily hear the reproach of the academic community to the not-so-academic Greenspan. The FOMC now swears by communication as a cornerstone of policy-making. Like many others, though, I have my doubts about its efficacy – it seems we have more volatility now, not less, with so many words to weigh now that there is more confusion than ever.

Enough ruminating for one week. Looking at the near term, despite Friday’s sell-off, the stock market is still in an overbought condition. Stock usually struggle in the days after the quarterly expiration, partly a rebalancing effect, but they usually have a better time of it on expiration Friday, too, leaving me to wonder if we’re in for more counter-trend behavior. With all of the uncertainty in the air, we should track sideways overall for a time, most likely with a downward seasonal bias, until the mess in DC can get sorted out – or rather, punted yet again.

The Economic Beat

It was a tale of two weeks for the economy. Perhaps most interesting was that the part of the week that preceded the Fed meeting featured data that was on the soft side in the main, while the data that came after the meeting was definitely more robust.

Both manufacturing and housing shared this curious dynamic. The week began with somewhat mixed news in industrial production, which the Fed reported as rising by 0.4% in August against expectations for a 0.5% gain. Manufacturing had a big (+0.7%) rebound from its August decline (-0.4%), with both months being defined by stops and restarts in motor vehicle production. The year-on-year rate jumped to 2.7% for industrial production and 2.6% for manufacturing, but as can be seen from the chart below, the challenge is for the overall downward trend to reverse, as we’ve had several rebounds from May 2012 that have proved short-lived.

Mild weather has constrained utility output for several months in a row, and we should eventually see a rebound from that sector (though since it will probably be due to cold weather, it won’t be celebrated outside of the utility group). It would be more tempting to make the argument that the ongoing weakness in utility output is understating industrial strength if the year-year changes for overall output overall and manufacturing weren’t virtually the same.

The New York Fed manufacturing survey also came in below expectations that morning, at 6.3 versus an expected 9.0, with new orders barely positive (though shipments had an encouraging rise in August).

Then the housing market report checked in with two mildly disappointing reports: the homebuilder sentiment survey was unchanged, while housing starts in August were definitely below expectations with a seasonally adjusted total of 891,000 versus expectations for 951,000. July was revised downwards and permits were also well short of expectations, though they at least got an upward revision to the previous month. Could the report have influenced the Fed? The homebuilders themselves have talked all year long of managing growth in a restrained manner.

Two days later, the existing home sales market was an entirely different color, as was manufacturing. The seasonally adjusted sales rate for existing homes rose to 5.48 million annualized, the highest level since February 2007. All-cash sales remain elevated, at 32% versus 27% a year ago, suggesting that there may not only be interest-rate related panic amongst individual buyers, but missing-the-boom panic amongst investors. The median price was up 14.7%, and the realtor’s association continues to complain about tight lending conditions. One would expect the initial stages of a housing recovery to be led by pools of investment money, but for it to be happening this late in the game implies rising levels of speculation.

Manufacturing’s tale of the tape improved with the more established (and influential) Philadelphia Fed survey reporting a strong jump to 22.3 in September from 9.3 in August (seasonally adjusted). The report was good across the board, with big improvements in new orders (+21.2) and shipments. Perhaps a note of caution came from a special question asking about production growth, which showed overall expectations for a weighted increase of only 1.6%. Yet the forward-looking questions are historically better gauges of current conditions than future ones; best to just wait and see.

The rest of the data was mixed. Consumer inflation as measured by the CPI fell to 1.5%, 1.8% excluding food and energy. Inflation has also been weak at the producer level and in international trade, where it’s been negative over the last twelve months. Weekly retail sales fell back as the frenzy from back-to-school subsided and balmy temperatures failed to turn out buyers for fall apparel, while weekly claims remained quite low yet tainted by ongoing problems out of California. It’s probably best not to infer much of anything from them this week. The claims data helped boost the month’s leading indicators, also aided by the resumption of auto production and a steepening of the yield curve that had everything to do with fears of the Fed and nothing to do with loan demand.

Next week brings the rest of the housing data in the form of Case-Shiller and federal agency price reports on Tuesday, August new home sales on Wednesday and pending September sales (existing homes only) on Thursday. Wednesday also brings the August report on durable goods, which ought to show a rebound if the manufacturing surveys are to be trusted. The Conference Board reports its consumer confidence measure on Tuesday, with perhaps the real report of the week being the latest read on personal income and spending on Friday.

Rounding out the week is another look at second-quarter GDP on Thursday, and assorted reports from various regional Fed banks: Chicago has its national activity index on Monday, Richmond reports regional manufacturing on Tuesday and Kansas City on Thursday.

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