Much Ado About Nothing


“When danger reared its ugly head, he bravely turned his tail and fled.” – Sir Robin’s song in Monty Python and the Holy Grail

It was one of the most anticipated (and over-anticipated) Federal Reserve meetings in ages last week, and in the end the Fed did what it has been doing the last few years – nothing. For the third year in a row, the Fed deferred making any pivotal decisions at its September meeting after having the financial markets on pins and needles. The stock market ended up with nothing on the week as well, but got there the hard way after following two days of big gains with two days of big losses.

If you’ve been a regular reader of this space, then you know to count me among the group that says the Fed has missed its opportunity to raise rates in this cycle. That’s not to say that the bank is certain not to raise rates at all the rest of the year, but given the way the cycle is fading, the task isn’t going to get any easier. Employment is still doing a good job of hanging in there, but some of the data going into the meeting, in particular the combination of a nasty-looking industrial production report with two negative scores from the banking system’s most influential surveys, New York and Philadelphia, probably gave the bank as much reason to blink as did the warnings coming from abroad.

On that score, both the IMF and World Bank had weighed in with recent warnings to the Fed not to raise rates, and in its just-released quarterly report the Bank of International Settlements had also mused over the volatility it saw as sure to follow in emerging markets. Our central bank duly opted to cite the issue of global stability in its statement, leading some to heckle from the sidelines about a newly-discovered “third mandate” (the other two, legally binding mandates being employment and monetary stability).

No doubt the committee took note of such other bank views and was happy to shift market attention there, but apart from employment (and the August report was no barn-burner), the rest of the economic data has been soft. Janet Yellen may have cited a 2.4% real GDP rate over the first half of the year as being a positive surprise from the last meeting, but that is so much whistling in the dark. With one month of data to go, the third quarter is tracking at 1.5%, we still have a large inventory bulge to work off going into the fourth quarter, growth rates are slowing everywhere and S&P profit growth has gone missing.

I don’t know if the data will co-operate enough for the Fed to get in any increase before year-end. Certainly the usual slew of counter-statement governor views designed to keep the markets guessing began to circulate the next day, with the emphasis this time on the near-inevitability of a rate increase. Some may believe the jaw-boning while others don’t, but the cycle will almost certainly end long before the Fed has the opportunity to get rates as high as 1%, and it may well end before any increase at all, as much as the bank may want to get in at least one or two token bumps. That will leave negative rates and more rounds of QE as the chief weapons against the next recession, and all I can say is that the bank better be hoping it’s a mild one.

What this all means for the stock market is not of unanimous opinion. Some, including Goldman Sachs, are already calling for a fourth-quarter rally that would get us back to the old highs and make the year a positive one for stocks. It could happen, but to get there we’ll have to ignore earnings in the process. With a scant two weeks to go in the quarter, FactSet has estimated Q3 S&P profit growth at (-4.4%). That number will typically fall at least another 100 basis points before the season begins in earnest, implying a negative quarter even after factoring in the usual cushion (it’s gotten bigger this year, another bad omen) of three or four percent. The hope is that we’ll begin to cycle “transitory” effects like the dollar and energy prices sometime in the next quarter or two, making comparisons easier, but at the end of the day, everything is transitory, including the business cycle. It doesn’t end with interest rate levels.

The Economic Beat

Apart from the Fed’s performance, the report of the week may have been the aforementioned, very anemic industrial production report, though retail sales are a much larger part of the economy.

The latter showed an August increase of 0.2%, seasonally adjusted, with an upward revision to July, but the twelve-month growth rate slowed to 3%. Below that is stall speed, which is where the year-to-date growth rate is (2.1%). Year-on-year August growth slipped to a seasonally adjusted 1.4%. Eight years in from the end of the last cycle, such levels are a big warning.

Industrial production fell 0.4% in August and slipped to a 0.9% rate of increase year-on-year, both figures seasonally adjusted and the latter the lowest in over five years. At least July was revised upward (0.9%).

The weakness was echoed in the regional Fed surveys, with New York reporting a very weak (-14.67) and Philadelphia a surprise negative 6, with zero neutral in both cases. The Philadelphia reading appeared to be somewhat at odds with its underlying components, implying some attitude downgrade by respondents – you mean to say the answers aren’t completely scientific? We’ll hear from the Richmond Fed survey on Tuesday and Kansas City on Thursday.

Homebuilding remain steady, with the sentiment index inching up a notch to 62 (neutral is 50) and housing starts still cruising through August with about an 11% year-to-date growth rate. This category will be amongst the last to roll over in the cycle; existing home sales are due on Monday and new home sales Thursday.

The FOMC staff also trimmed its outlook, as usual, but its forecasts are, like China, so institutionally constrained that they cannot be taken too seriously. If stocks are hopeful of more Fed-cowing news this week, the place to look will be durable goods on Thursday. The latest calculation of second-quarter GDP is expected on Friday, with no change to the previous estimate being expected. The real key to the stock market this fall will be corporate profits.

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