The Seinfeld TV comedy series (1989-1998) had a set of episodes, known as Jerry’s Bizarro World, where everything “normal” was turned upside down and inside out. The Fed seems to have accomplished something similar with its experimental Quantitative Easing (QE) policies. For the first time in a long time, underlying economic fundamentals are turning positive. Ordinarily, this would be good news for investors. But in today’s upside down, topsy turvey, bizarre markets, “good” news is bad for investors. The blame for this is squarely on the Fed’s QE policies and similar policies adopted by other central bank mimes.
The Good News
In the labor markets, job openings continue to be hard to fill (JOLTS report), layoffs and firings are at levels not seen since ’07 (Initial Jobless Claims week of August 10), and Voluntary Quits (“Take This Job and Shove It”) are rising. The consumer appears to be holding her own (retail sales) and deleveraging appears to be on its last legs (rising credit card and auto debt). Europe looks like it has bottomed (positive Q2 GDP growth) and the news from China shows higher growth levels than penciled in by the pundits. Normally, such news would be accompanied by rising equity prices. But not this time. In the U.S., the U.K., Europe, and Japan, recent positive economic data has been met with equity market sell offs. On August 15th, the Dow Jones sold off 218 points despite 5 year lows in jobless claims, a continuation of positive retail sales trends, and high and rising home builder confidence, a good leading indicator of future home sales. The table shows the performance of the world’s equity markets with activist central banks for the year until the Fed’s “tapering” announcement on May 22nd, and then from May 22nd to August 15th, the date of this writing. Note that until May 22nd, the markets with activist central banks performed quite well despite relatively stagnant economies, but after the “tapering” announcement, equity prices have been less than stellar. Normally, during the first signs of a change in policy toward tightening, what we find is both rising interest rates and rising stock prices because monetary policy tightening means a strengthening economy.
The Bizarro World
David Patterson of Brandywine Trust Group, in an August 15 Wall Street Journal piece, opined that markets no longer move on fundamental economic data, but on anticipated Fed policy moves. In fact, it isn’t so much the policy change itself that moves the markets, but whether or not that change was more or less than anticipated (i.e., the 2nd derivative). Patterson’s premise is that the market knows that the Fed is counting on the “wealth effect,” via a rise in equity prices, to have an impact on consumption, and anticipates and discounts Fed actions to achieve that “wealth effect.” If the Fed acts (or fails to act), and its actions (or lack thereof) disappoint market expectations, equity prices react negatively. As a result, because “good” fundamental economic data means a stronger economy and less need for monetary accommodation, we now have the bizarre world where “bad” fundamental economic news moves the markets higher, while “good” news does the opposite. That is, “bad” is now “good,” and “good” is “bad.” Patterson sums up the Fed’s Bizarro World as follows. The process can at some point turn powerfully negative, if the monetary stimulus stops, or is expected to stop, or becomes ineffective, which it will if it is expected to become ineffective, because it is only effective based on what the market expects. (emphasis added) There are no special attributes of wisdom that are automatically imparted to the Fed’s Chair at his/her swearing in ceremony. The non-traditional policies adopted by the Bernanke Fed, and mimicked by other major central banks, are experimental. Going in, they did not know what the unintended consequences would be. But now we are getting a glimpse. At this writing, we do not know how the Fed’s September decision about the “tapering” of its QE program will impact the equity markets. Will it disappoint, or not? But, what we do know is that in the Fed’s new bizarro world, whatever that decision may be, and whether it disappoints market expectations or not, market reaction will not be tied to economic reality.
Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778. Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.
