The Finance Gourmet

Personal Financial Advice from a former Certified Financial Planner

November Looking Funky for Stock Market

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These last few weeks have dumped piles of external events onto the stock markets. As usual, the market overreacts to many of these and under-reacts to others. For long-term investors, this is just another reason to have a well diversified portfolio that you rebalance regularly.

Market Data and Other Stuff

Just because you aren’t going to panic sell (right?) or run out and buy fearing you are missing the start of another rally (right?), doesn’t mean that we can’t take a look at what is going on in the economy, markets, and politics that might affect our investments over the coming months.

First up? The Fed!

President Trump has announced his pick for the next Federal Reserve Chairman, and it’s a known quantity. Jerome Powell is already on the Federal Reserve Board and holds views that are considered mostly similar to those of current Fed Chair Janet Yellen. In fact, many analysts suggest that there is no real purpose in replacing Yellen with Powell other than for the President to put his stamp on the board.

stock market end of year economy

It all adds up to more of the same. A Federal Reserve focused on “normalizing” interest rates (raising them) despite the economy coming in well below anything approaching the Fed’s so-called 2% inflation target. Look for one more rate increase in 2017, or a January 2018 increase unless something goes kablooey between now and then.

Next? The Economy!

Jobless claims were up, but everyone is attributing that to the effect of the hurricanes. This analysis is borne out by the fact that continuing unemployment claims (people who were already on unemployment last period continuing to be on it this period) falling. Add it up and the job market is doing fine. Not on fire, but not shedding jobs either.

The Big Bad Wolf in our story, however is the Producer Price Index. Expected to come in with a 0.1% gain, the report showed the index rose 0.4% in October. Typically, big surprises like this get revised back the following month, but even a 0.3% increase is a pretty big deal. This finally is actual evidence that inflation may be building in the economy.

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So, the rub is that the latest increase the Fed made to interest rates is still working its way through the economy. The question is, would that increase be enough to slow inflation, or do we need another? The answer, whether it is right or wrong, according to the Fed is that we need another increase. With this report, there is no doubt we’ll get one, unless there is a kablooey.

How about Earnings?

Stocks have performed almost exactly like you would expect them too. Companies that have been troubled lately reported earnings that were troubling. Companies that people expected to be doing well, had good earnings. Maybe the only surprise was Wal-mart, who did even better than expected, after doing better than expected already earlier this year.

For doomsayers who worried about the company’s future in the wake of its decision to boost up the minimum wage it pays employees, it looks like Wal-mart has figured out how to make money anyway.

Finally… Politics!

Tax cuts are coming! Tax cuts are coming! Or maybe not. You never know with Washington. Wall Street loves a tax cut, and the Fed loves calling tax cuts inflationary, but the current tax cut bill in Washington doesn’t really cut taxes so much as move them around a bit.

It takes back certain itemized deductions, in order to give out a bigger standard deduction. If anything, this tax bill might make your taxes a tiny bit simpler if you are one of those taxpayers who it near the break-even point on itemizing versus taking the standard deduction.

Now What?

It’s end of year time! That means that all of this is about to become meaningless background noise. When it comes to the U.S. economy, nothing is more important than holiday shopping season. If analysts get worried about holiday spending, the markets are heading down. If they like what they see, they’ll get a boost.

Often no one can tell if things are good or bad until the companies tell us next year. That’s why you often see a Santa Claus rally in December when in the face of limited data, spending seems good enough.

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Watch out for a bumpy January though. A Fed rate hike, plus actual holiday data, plus a new year, might just set us up for a solid correction in early 2018. Whether it sticks around, or is a temporary blip will depend almost entirely on if the job market keeps on going.

Kablooey!

You never know what will happen that has nothing to do with balance sheets, interest rates and economic data that can send everything sideways.

Kablooey is when something blows up (usually metaphorically, but not always) that causes a shock to the markets. There seems to be a lot of potential kablooey out there ranging from increasingly bizarre politics only loosely tethered to reality, to North Korea, to Russia, to the Russia investigation, to environmental issues, to terrorism. If something goes kablooey all this analysis goes out the window and we start over.

Yellen Admits 2% Target Is Phony

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Janet Yellen admitted that the Fed’s two percent inflation target is largely phony. She didn’t say that in as many words of course.

What she actually said was

It would be imprudent to keep monetary policy on hold until inflation is back to 2 percent

On the one hand, that makes sense. The levers that steer the economy do so more like those that control a supertanker, and less like the steering wheel of a Tesla. So, the Fed Chairwoman is right that you can’t simply wait for inflation to hit 2% and then start raising interest rates. That could lead to a hard landing, or worse, not work at all.

Stealth Inflation

But, that isn’t what she meant. What she meant was that there is no data indicating that inflation will be 2% anytime soon, but that doesn’t square with what she thinks is/maybe/will be happening in the economy. You see, she is convinced that inflation is hiding somewhere, cloaked in stealth mode, undetectable by economic statistics, like some sort of cloaked Klingon finance battleship.

That seems to be a popular theory because of two factors. One, the stock market keeps going higher, and people are starting to worry (a lot) that it is overvalued. The second is that this expansion, while slow and halting, has been going on for about 7 years now. That “should” be the time where a rising economy and a rising stock market combine to start driving up inflation.

ostrich head in sand - rate hike without data

The data, however, suggests no such thing. What Yellen and the others can’t seem to come to terms with is that just because employment as a percentage is rising, wages are not. This doesn’t square with what they were taught in economics school 40 years ago, where rising employment also drives up wages. Wages, of course, are pretty much the biggest driver of inflation.

Jobs But No Wages

Unfortunately, a funny thing happened on the way to the inflation forum. Business, with layoffs and a crumbling economy fresh in the rear view mirror have been very cautious on hiring. There are many more part-time workers, or contract workers. In addition, they are erring on the side of hiring too few workers and just making do. Sure, there are drawbacks, but they, like the Fed and the market soothsayers, see the end coming, but they can’t see when.

As a result, hiring is bare minimum, and that not only doesn’t push up wages, it keeps them very much in check. A guy asking for a significant raise doesn’t look all that necessary if you think maybe you can keep the shop running with one less employee.

Add it all up, and the market is missing the key ingredient in real, worrisome inflation, higher wages. There are no job hoppers scoring bigger and bigger paychecks. There are no companies out there hiring the barely qualified just to get bodies in the door. Many of the people listed as “employed” in those government statistics still haven’g gotten a job anywhere near as good, or well paying as the job they lost back in 2007 to 2010.

In other words, the Fed is raising rates based on “shoulda” and “coulda” regardless of data. When they do that,the same thing happens every time: the market crashes and it takes big sectors of the economy with it.

If Yellen and company continue down the path of insisting that the data is wrong, and that their gut is right, the next financial problem won’t be a stock market bubble, it will be another great recession. (That will pop the market though, and anyone who said they thought the stock market was overvalued any time in the last 24 months will insist they “were right.”)

Rate Hike Dead for 2017

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Ding, dong, the rate hike is dead. (Or at least is should be.)

What should have been obvious since the beginning of this year to anyone who wasn’t trying to burnish their “hawk” credentials became undeniable this morning. Inflation is non-existent, jobs are faltering, and the economy is most definitely not overheating, even if you think the stock market is.

Durable Goods Orders Crater

Earlier this year, the Fed was looking at three, or maybe even four interest rate hikes. They pulled the trigger twice in 2017, with a rate increase in March, and another in June. Ever since then, however, the economic numbers just don’t support another hike. They never really did, but Fed officials glossed over that problem by saying the numbers were temporary.

durable goods report bulldozer

With every new economic number to come out, however, it looks like those numbers were not only not temporary, they were part of a growing trend of an economy that is already slowing down, and maybe getting ready to reverse. Instead, it’s the “good” numbers that look like they were temporary.

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After a big increase in June, orders for durable U.S. goods fell 6.8% for July, suggesting June’s big number was the temporary number. Combine that with the fact that inflation nowhere near the Fed’s 2% target, and you have to keep asking yourself, what is the point of more rate hikes to stop non-existent inflation, and an economy that is most definitely not overheating?

Why Raise Rates in 2017 Still?

The answer is two-fold.

The unfortunate part of the answer is that there is something of an unwritten competition between certain kinds of economist as to who can be the bold on interest rates. They love being called inflation hawks, because that seems like the more responsible position. It’s kind of like the stern parent telling you to take your medicine because it is good for you. But, just like taking antibiotics when you aren’t sick is neither strong, nor prudent, raising interest rates in an economy that doesn’t support such increases is foolish.

The second reason for raising interest rates is to reload, so to speak.

The Fed’s primary tool for boosting a sagging economy is to cut interest rates, but you can’t get blood from a turnip.

With interest rate so low already, there simply isn’t room for much cutting. Sure, the Fed can snip back another 0.25% a few times, but that won’t do much in the face of an economy that slumps in what is still already a historically low inflation environment. And, with the Fed’s balance sheet already astronomically large, there aren’t a lot of non-interest rate tools left either. This is at least a sensical argument.

Damned If You Do…

So, here’s the dilemma. Raising rates may trigger the very recession that would necessitate cutting rates in the first place. In this case, not raising rates is the much smarter move. However, the expansion we are currently in has been a long, if tepid, one. The cyclic nature of the economy suggests that a contraction is coming sooner or later regardless of what happens in interest rates. In this case, reloading the Fed’s weapons makes sense.

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For my part, I follow the maxim, “Don’t borrow trouble.”

There is no economic overheating, and no inflation, so don’t go worrying about what you will or won’t do when and if trouble comes. Instead, manage the economy for as much solid growth as possible and let the universe sort out when the contraction comes. A few more years of reasonable accommodation might just give this expansion another three or four years. In that time table, plenty of well-timed rate increases will reload the Fed’s arsenal, without prematurely puncturing the wheels of expansion.

 

Inflation Disappears (Again)

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Update: Yea! It looks like I was right, and everyone has come around. It’s August now, and it looks like those low inflation numbers were neither an aberration, nor temporary. There simply is no inflation, the job market, while full, is not hot, and there is no need to raise rates the rest of 2017, so say we all 🙂

The Fed has been working to raise interest rates because of the specter of inflation. However, with the exception of energy prices, there really hasn’t been much in the way of inflation. As a result, the Fed keeps explaining that they think that all those reports of low inflation were temporary.

That all took a bit of knock today as the U.S. Government reported that inflation in June was zero. That’s right, zero, as in no inflation (again). And that comes after the actual 0.1% drop in inflation in May. This is of course, a far cry from the Fed’s so-called target of 2.0% inflation, and calling two months in a row of data temporary starts to look like ignoring data, so the tone has changed. A lot hinges on the July report.

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Fed Chair Janet Yellen said in remarks that the Federal Reserve might have to pause its march of interest rate hikes if inflation stays low, but then came back to say that inflation might still be hiding in the form of rising wages. Ironically, the Labor Department report shows that while unemployment is falling, wages are not increasing by much.

no inflation

In other words, there is currently no inflation, and no wage pressure. The only reason left to push for higher interest rates is that it is cooler on Wall Street to play for Team Hawk.

That won’t stop certain bankers from pushing for more rate increases, but if July’s numbers come in like this, they won’t have much of a leg to stand on. On the other hand, if July’s numbers turn around, they will pounce and declare that those low inflation numbers were temporary aberrations and that THESE JULY numbers are the real numbers and we can totally trust that these numbers are legitimate and not temporary like those other numbers that didn’t fit the rate hike agenda.

What it all comes down to is that July’s numbers are going to be a VERY big deal for the stock market and the Fed agenda. If you like to play some volatility trades, put them on for the July inflation reports. Everyone else, prepare for a bumpy ride.

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