March 19, 2021
By Steve Blumenthal
“This is not the end, this is not even the beginning of the end,
this is just perhaps the end of the beginning.”
– Sir Winston Churchill
On a warm summer’s evening
On a train bound for nowhere
I met up with the gambler
We were both too tired to sleep
So we took turns a-starin’
Out the window at the darkness
The boredom overtook us
And he began to speak
– “The Gambler”
by Kenny Rogers
The Fed kept its policy rate unchanged on Wednesday. Not a surprise. And he began to speak. Chairman Jerome Powell said the Fed expects real gross domestic product to grow 6.5% in 2021. A sharp boost from its 4.2% forecast in December. He said the Fed does not plan to raise interest rates until 2024.
Notable is the following change in the Fed’s statement since its December meeting:
A taste of your whiskey… Courtesy of Rogers:
He said, “Son, I’ve made a life
Out of readin’ people’s faces
Knowin’ what the cards were
By the way they held their eyes
So if you don’t mind my sayin’
I can see you’re out of aces
For a taste of your whiskey
I’ll give you some advice”
My Camp Kotok fishing economist friend Sam Rines wrote:
- In the end, the FOMC made it clear that some inflation will be tolerated, and Chair Powell hammered home that point.
- It does have side-effects. Inflation expectations should continue to creep higher.
- There is a bit of a warning embedded in the Fed’s message, though. This growth surge is temporary, the sugar high is not going to last, and the Fed is not going to react to it.
Sam concluded, “While the decision to not raise rates and maintain the pace of QE was not a shock to markets, the directness of Powell’s commitment to realizing inflation and employment outcomes was a bit of a shock. When asked about tapering QE, Powell said “substantial further progress” toward the dual mandate was needed. Critically, there was the promise of giving plenty of forewarning. That combination means QE is not going anywhere, anytime soon.” (Hat tip to Sam for today’s intro quote as well.)
So I handed him my bottle
And he drank down my last swallow
Then he bummed a cigarette
And asked me for a light
And the night got deathly quiet
And his face lost all expression
Said, “If you’re gonna play the game, boy
You gotta learn to play it right”
What matters is the potentially devastating combination of inflation and unemployment, which remains woefully high. Inflation means it costs you more to get less. Further increasing financial stress and widening the growing divide. Inflation is not for the faint of heart. Transitory? Maybe. Maybe not.
You’ve got to know when to hold ’em
Know when to fold ’em
Know when to walk away
And know when to run
One of the straight shooters out there is former Dallas Fed president Richard Fisher. On CNBC Wednesday evening, Fisher was asked how important the Fed’s move from a proactive Fed to a reactive Fed was, and whether such a move was dangerous.
It is important, and there is a risk here because you have to remember it takes a lot of time for monetary policy to work its way into the real economy, I’m not talking about market reaction. And if you are reactive, first of all data is out of date by the time you get it, even though we’re getting better at getting contemporary data. If you are reactive, (Fed policy) is going to take time to work into the economy and I think that’s the risk rather than anticipating and using your judgment, going forward, as to what’s likely to happen if, let’s say the bond market determines the 10-year rate.
If the bond market begins to price in some inflationary pressure. The Fed does its work, gets its data, finds out there is more than transitory inflation in play, then they have to tighten or do whatever they need to do. It (policy) takes a while to work into the economy and it (being reactive) will therefore be, I think, be less effective. That’s a risk they’re running.
Fisher learned from the school of hard knocks. He’s smart, well-educated, and has real-life business experience. A little background, pulled from Wikipedia:
He attended the United States Naval Academy in Annapolis, Maryland from 1967 to 1969, before transferring to Harvard, where he earned a bachelor’s degree in economics in 1971. He then earned an MBA from Stanford.
Afterward, Fisher moved to New York City and joined the investment bank Brown Brothers, Harriman and Company, where he was assistant to former Undersecretary of the Treasury Robert V. Roosa, and specialized in fixed income and foreign exchange markets.
From 1978 to 1979, he served as special assistant to Secretary W. Michael Blumenthal at the United States Department of the Treasury, where he worked on issues relating to the dollar crisis. Returning to Brown Brothers, he established and managed the bank’s Dallas-based Texas operations.
In 1987, Fisher founded Fisher Capital Management, and a separate funds-management firm, Fisher Ewing Partners, and managed both firms until 1997.
I don’t believe his “go-to” is economic theory; I believe he operates from an understanding of how businesses and people think and behave.
Every gambler knows
That the secret to survivin’
Is knowin’ what to throw away
And knowin’ what to keep
‘Cause every hand’s a winner
And every hand’s a loser
CNBC asked Fisher, “There’s a lot of talk about transitory inflation and how far they would let it go. Coming back ultimately to this 2% inflation target, how far do you think they would let inflation go, before they felt the need to do something?”
Here’s the problem: If you’re a supply-side economist, you’re also thinking about the kind of cost pressures that are now underway, raw materials, freight—I can go on and on and on. However, a business operator also has to worry about what other new costs are going to be imposed—higher taxes, perhaps unionization, minimum wage efforts, etc.
So, on top of what they’re already seeing, they are likely or possibly going to price in a reaction, and it’s very rare in my experience to have businesses price in an increase, and then take it back. So he’s right, in terms of, compared to the low levels of which we were a year ago.
- But the problem is it’s the dynamic of going forward and how do businesses react? So that’ll determine how transitory it is.
- I think what the market is doing is questioning that premise. Look at the 10-year and a five-year yields, the world is questioning that premise.
Will we have transitory inflation, or will it become more embedded? And this isn’t 4 or 5% inflation, I’m just saying above the two-plus level, which the Fed won’t articulate, and I understand why he won’t… But you can build in a behavioral reaction here, and then the Fed has to take the time to respond, and it then takes time for that to play its way through the economy. Which means it could feed its way into itself, that’s the point I’m trying to make.
And when he’d finished speakin’
He turned back toward the window
Crushed out his cigarette
Faded off to sleep
And somewhere in the darkness
The gambler he broke even
But in his final words
I found an ace that I could keep
Fisher concluded, “What I’m more interested in is how the market perceives this.”
You’ve got to know when to hold ’em
Know when to fold ’em
Know when to walk away
And know when to run
You never count your money
When you’re sittin’ at the table
There’ll be time enough for countin’
When the dealin’s done
Watch the 10-year Treasury. Watch the dollar. You’ll find both charts in the Trade Signals section next. Do take a look at the spike in the 10-year yield.
Trade Signals – The $1.9 Trillion Dollar Jet Stream
March 17, 2021
S&P 500 Index — 3,942
Posted each Wednesday, Trade Signals looks at several of my favorite equity market, investor sentiment, fixed income, economic, recession, and gold market indicators. Market trends persist over time and stem from changes in risk premiums or the amount of return investors demand to compensate them for the risks they take.
Risk premiums vary a great deal over time in response to new market information or changes in the economic environment or even changes in investor sentiment. When risk premiums increase or decrease, stocks, bonds, and other assets have to be priced again. Investors react to the changes gradually and this creates trends.
Rules-based trend following strategies don’t predict, they react to what prices are telling us about supply and demand. More buyers than sellers, price moves higher and more sellers than buyers, price moves lower. Trend-following strategies seek growth opportunities while maintaining a level of protection in down markets.
Notable this week:
Jet streams are relatively narrow bands of strong winds in the upper levels of the atmosphere. The winds blow from west to east and tend to be strongest in the winter. I love when the pilot announces a strong tailwind at our back. It can shave more than an hour off the ride home.
The $1.9 trillion economic tailwind is picking up speed. To date, COVID-19 fiscal support totals $5.2 trillion. That represents over 24% of US nominal GDP. Wall Street analysts are projecting real GDP will increase 6.5% to 7.0% this year. “Real” means after inflation. Let’s call inflation 2% to 3%. Better to juice the jet stream is the thinking.
Heading to 2%?
Housing construction prices are rising. Lumber, Dr. Copper… higher. Rising food and health care costs are equally concerning. No inflation they say? The famous Naked Gun scene comes to mind: “Nothing to see here!”
Transitory? Maybe in the short term. In the long term, as Bill White, the former head of the Bank for International Settlements, said, “In the end, there will be inflation.”
To be watched is the move up in interest rates. The direction is important. The downtrend line from 3.24% in 2018 to a 0.40% to 0.50% low was broken last fall. Since then, rates have risen with little pause at the 1.40% to 1.50% resistance level. The bond market is concerned about rising inflation. The next level of resistance is 2%. The stock market, especially tech, is becoming concerned with rising interest rates. (Note to regular Trade Signals readers: I’ve updated the 10-year Treasury chart from Wednesday’s 1.68% to today’s 1.75%.)
A good percentage of the new stimulus money will likely find its way into stocks. Thus, I believe there is more run in the bull market run. Buy the small dips as long as the weight of equity market trend evidences is bullish. You’ll see in the Trade Signals Dashboard section below.
At some point, rising rates will call Powell to task. I’m keeping a close eye on the Zweig Bond Model (ZBM). It isn’t perfect—nothing is—but it has done a good job for me over many years. The ZBM has been in a sell signal all of 2021 to date and, with the exception of a few short weeks, since late September 2020. The high-yield bond signal is in a sell as well. Keep stop losses and downside risk-hedged risk protection in place.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.
Click here for this week’s Trade Signals.
Personal Note – California and Utah
I’m excited and, frankly, a little anxious at the same time. Saturday morning, I’m boarding a flight to San Diego. Ahead is a 12-day trip: four in California and eight in Utah. I’ll be working and playing. Golf is lined up for Sunday at a course called Maderas. I hear it is outstanding.
Next Wednesday, I land in Salt Lake City, arriving at about the same time as three of my kids. We will be spending four days in Park City with good friend and way too gracious host Ben Fulton. Ben and I bonded a number of years ago in the back country; he pulled me out of some deep powder and I later returned the favor. If you’ve ever skied deep powder snow, you know the joy of floating down the mountain. You also know that all the work that goes into digging yourself up and out. Always have a partner nearby.
We’ll spend the last four days of our trip at Snowbird, Utah. This year is number 42 for me. Dad first took me when I was 19. We’ll be celebrating my 60th birthday next Friday. Wow.
It was just a blink ago that the kids arranged a scavenger hunt. I was required to wear a unique outfit—complete with shower cap, bra, and skirt. If I solved a clue, I got to remove the shower cap; solved next clue, then the next piece; and so on.
I got more than a few odd looks, as I should have… But I did walk away with a new white Snowbird hoodie as my birthday prize. I’m packing it for old times’ sake. No dressing up this year. Or ever again. Daddy’s reaching a more mature stage of life.
Temperatures look good in San Diego (like I even needed to look) and I’m smiling as I see snow in the forecast in Utah late next week. I’m really looking forward to time with the kids.
The team expanded in 2012 when Susan and I married.
Wishing we were all able to meet in Utah this year—hopefully next year. Time is moving much too fast.
Wishing you good fun, and the good sense to never let your kids talk you into donning a shower cap, bra, and skirt.
Have a great week,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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