“I have seen this movie before,” says Rosenberg
The paragraphs below come courtesy of David Rosenberg, Chief Economist and Strategist of Gluskin Sheff & Associates.
Two weeks ago, Ben Bernanke congratulated himself on CNBC for helping to boost the Russell 2000 by 30%.
More recently, the San Francisco Fed Reserve Bank published a report doing likewise, citing QE2 as a success because the inflation rate is currently a percentage point higher than it would have been absent the Fed intervention.
Everyone should be made aware of the insanity of it all, and that preserving their capital and growing it slowly and prudently is a totally appropriate strategy for this radical money easing environment. This type of policy breeds speculative and dubious rallies, but what they inevitably trigger are boom-bust cycles such as the ones we saw in 1999-2002, 2006-2009, and the current one we are in today. This is no time for short memories.
The Fed has created an “inflation” mentality in commodities, foodstuffs and stocks ― aided and abetted from a U.S. dollar that has sunk back to two-month lows. At the same time there is still a “deflation” mentality for many final consumer goods, which is unlikely to change until the employment picture improves further.
Incomes are unlikely to keep up with “headline” inflation, so the first reaction is for consumers to draw down their personal savings. We saw that in classic fashion in the Q4 real GDP report.
The Fed has all but given up on trying to create wealth by reviving the housing market. That was QE1, which concentrated on expanding the central bank’s balance sheet via mortgage loans. But the headwinds from the ongoing foreclosure crisis and lingering massive excess supply are once again weighing heavily on real estate values.
The structural impediments are far beyond the Fed’s control, so QE2 has been all about forcing investors to rebalance their portfolios in favour of the equity market, which is outside its mandate but cloaked in the form of stating that inflation is too low (obviously not including the trip to the gas station or grocery store). The Fed’s manipulation of relative asset prices is so epic that it has replaced China as the single largest owner of Treasury securities ($1.1 trillion on its balance sheet).
Home prices in the U.S. are resuming a downtrend and soon we will see the household sector having to rebuild its savings without aide from the government. The view that Washington takes care of everything will disappear with looming austerity. This year it is a state and local government story, next year it will be the federal government.
With short-term rates at zero combined with increasing food and energy prices, this is obviously bad news for savers. It is an illusion of prosperity that has been created, but it won’t last. Given the intractable nature of the U.S. fiscal deficit, the Fed needs to encourage more domestic savings but it will not, at least for now, due to near-term deflation fears.
The aim here for the Fed is a reflationary wealth effect via rising equities; buying time until the market for jobs and homes turns around on a sustained basis. The offset is the pinch to real wages from not only ongoing excess capacity in the labour market, which Bernanke does not see ending for another five years, but from the Fed’s own policies that have exacerbated the punishing run-up in food prices.
It sounds like a cliché, but I have little doubt that this cyclical bull market will end in tears. Admittedly, however, there could be more upside near-term, but a last gasp I would expect, especially now that the retail client has thrown up his/her hands, thrown in the towel, and moved back into equities after the market has already doubled. That is human nature, and it is a classic contrary signpost (as per Bob Farrell’s Rule number 5).
In the end, we will look back at the FOMC dissenting rogue, Kansas City’s Tom Hoenig, in the sense that he had it right all along. The Fed needs to stop QE2 and get rates to around 0.5-1.0% as soon as possible. Zero rates and asset purchases are fine in a crisis, but in order to build long-term savings and foster efficient longer term capital allocation, it can become counter-productive.
I can go on but I have seen this movie before. It will end in further wealth destruction via a stock market blow-up or significantly higher inflation down the pike. Given the record structural deficits and the “kick-the-can-down-the-road” monetary and fiscal policies I see no other outcome. Just remember what happened the last time the Fed contemplated an exit strategy ― that, you don’t need a long memory for. It was not even a year ago and precipitated the near-20% May-June market correction.
Source: David Rosenberg, Gluskin Sheff & Associates – Breakfast with Dave, February 3, 2011.
More on this topic (What's this?)
Anticipating The Rate Hike (Disciplined Approach to Investing, 8/14/15)
Rising Interst Rates Historically A Positive For Equity Returns (Disciplined Approach to Investing, 9/3/15)
Federal Reserve Hinting at Raising Rates This Year (Jutia Group, 6/18/15)
2 comments to “I have seen this movie before,” says Rosenberg
Performance Optimization WordPress Plugins by W3 EDGE